MODULE 2 Thus GDP by expenditure method at market prices = C+ I + G + (X – M), where (X-M) is net
export which can be positive or negative.
National Income: Definition, Concepts and Methods of Measuring National Income
National income is an uncertain term which is used interchangeably with national dividend,
national output and national expenditure. On this basis, national income has been defined in a
number of ways. In common parlance, national income means the total value of goods and
services produced annually in a country. In other words, the total amount of income accruing
to a country from economic activities in a year’s time is known as national income. It includes
payments made to all resources in the form of wages, interest, rent and profits.
Definitions of National Income:
The definitions of national income can be grouped into two classes: One, the traditional
definitions advanced by Marshall, Pigou and Fisher; and two, modern definitions.
The Marshallian Definition:
According to Marshall: “The labour and capital of a country acting on its natural resources
produce annually a certain net aggregate of commodities, material and immaterial including
services of all kinds. This is the true net annual income or revenue of the country or national
dividend.” In this definition, the word ‘net’ refers to deductions from the gross national income
in respect of depreciation and wearing out of machines. And to this, must be added income
from abroad.
The Pigouvian Definition:
A.C. Pigou has in his definition of national income included that income which can be
measured in terms of money. In the words of Pigou, “National income is that part of objective
income of the community, including of course income derived from abroad which can be
measured in money.”This definition is better than the Marshallian definition. It has proved to
be more practical also. While calculating the national income now-a- days, estimates are
prepared in accordance with the two criteria laid down in this definition.
First, avoiding double counting, the goods and services which can be measured in money are
included in national income. Second, income received on account of investment in foreign
countries is included in national income.
Fisher’s Definition:
Fisher adopted ‘consumption’ as the criterion of national income whereas Marshall and Pigou
regarded it to be production. According to Fisher, “The National dividend or income consists
solely of services as received by ultimate consumers, whether from their material or from the
human environments. Thus, a piano, or an overcoat made for me this year is not a part of this
year’s income, but an addition to the capital. Only the services rendered to me during this year
by these things are income.” Fisher’s definition is considered to be better than that of Marshall
or Pigou, because Fisher’s definition provides an adequate concept of economic welfare which
is dependent on consumption and consumption represents our standard of living.
Modern Definitions: From the modern point of view, Simon Kuznets has defined national
income as “the net output of commodities and services flowing during the year from the
country’s productive system in the hands of the ultimate consumers.”
1 3
Fourth, the transactions which do not arise from the produce of current year or which do not
contribute in any way to production are not included in the GNP. The sale and purchase of old
goods, and of shares, bonds and assets of existing companies are not included in GNP because
these do not make any addition to the national product, and the goods are simply transferred.
Fifth, the payments received under social security, e.g., unemployment insurance allowance,
old age pension, and interest on public loans are also not included in GNP, because the
recipients do not provide any service in lieu of them. But the depreciation of machines, plants
and other capital goods is not deducted from GNP.
Sixth, the profits earned or losses incurred on account of changes in capital assets as a result of
fluctuations in market prices are not included in the GNP if they are not responsible for current
production or economic activity.
For example, if the price of a house or a piece of land increases due to inflation, the profit
earned by selling it will not be a part of GNP. But if, during the current year, a portion of a
house is constructed anew, the increase in the value of the house (after subtracting the cost of
the newly constructed portion) will be included in the GNP. Similarly, variations in the value
of assets, that can be ascertained beforehand and are insured against flood or fire, are not
included in the GNP.
Last, the income earned through illegal activities is not included in the GNP. Although the
goods sold in the black market are priced and fulfil the needs of the people, but as they are not
useful from the social point of view, the income received from their sale and purchase is always
excluded from the GNP.
There are two main reasons for this. One, it is not known whether these things were produced
during the current year or the preceding years. Two, many of these goods are foreign made and
smuggled and hence not included in the GNP.
Three Approaches to GNP:
After having studied the fundamental constituents of GNP, it is essential to know how it is
estimated. Three approaches are employed for this purpose. One, the income method to GNP;
two, the expenditure method to GNP and three, the value added method to GNP. Since gross
income equals gross expenditure, GNP estimated by all these methods would be the same with
appropriate adjustments.
1. Income Method to GNP:
The income method to GNP consists of the remuneration paid in terms of money to the factors
of production annually in a country.
Thus GNP is the sum total of the following items:
(i) Wages and salaries: Under this head are included all forms of wages and salaries earned
through productive activities by workers and entrepreneurs. It includes all sums received or
deposited during a year by way of all types of contributions like overtime, commission,
provident fund, insurance, etc.
(ii) Rents: Total rent includes the rents of land, shop, house, factory, etc. and the estimated
rents of all such assets as are used by the owners themselves.
5 7
GDP at Factor Cost:
GDP at factor cost is the sum of net value added by all producers within the country. Since the
net value added gets distributed as income to the owners of factors of production, GDP is the
sum of domestic factor incomes and fixed capital consumption (or depreciation).
Thus GDP at Factor Cost = Net value added + Depreciation.
GDP at factor cost includes:
(i) Compensation of employees i.e., wages, salaries, etc.
(ii) Operating surplus which is the business profit of both incorporated and unincorporated
firms. [Operating Surplus = Gross Value Added at Factor Cost—Compensation of
Employees—Depreciation]
(iii) Mixed Income of Self- employed.
Conceptually, GDP at factor cost and GDP at market price must be identical. This is
because the factor cost (payments to factors) of producing goods must equal the final value of
goods and services at market prices. However, the market value of goods and services is
different from the earnings of the factors of production.
In GDP at market price are included indirect taxes and are excluded subsidies by the
government. Therefore, in order to arrive at GDP at factor cost, indirect taxes are subtracted
and subsidies are added to GDP at market price.
Thus, GDP at Factor Cost = GDP at Market Price – Indirect Taxes + Subsidies.
Nominal and Real GDP:
When GDP is measured on the basis of current price, it is called GDP at current prices or
nominal GDP. On the other hand, when GDP is calculated on the basis of fixed prices in some
year, it is called GDP at constant prices or real GDP.
Nominal GDP is the value of goods and services produced in a year and measured in terms of
rupees (money) at current (market) prices. In comparing one year with another, we are faced
with the problem that the rupee is not a stable measure of purchasing power. GDP may rise a
great deal in a year, not because the economy has been growing rapidly but because of rise in
prices (or inflation).
On the contrary, GDP may increase as a result of fall in prices in a year but actually it may be
less as compared to the last year. To rectify the underestimation and overestimation of GDP,
we need a measure that adjusts for rising and falling prices.
This can be done by measuring GDP at constant prices which is called real GDP. To find out
the real GDP, a base year is chosen when the general price level is normal, i.e., it is neither too
high nor too low. The prices are set to 100 (or 1) in the base year.
In particular, the increase or decrease in inventory is added to or subtracted from it. The
inventory includes produced but unsold manufactured and semi-manufactured goods during
the year and the stocks of raw materials, which have to be accounted for in GNP. It does not
take into account the financial exchange of shares and stocks because their sale and purchase
is not real investment. But depreciation is added.
(iii) Net foreign investment: It means the difference between exports and imports or export
surplus. Every country exports to or imports from certain foreign countries. The imported
goods are not produced within the country and hence cannot be included in national income,
but the exported goods are manufactured within the country. Therefore, the difference of value
between exports (X) and imports (M), whether positive or negative, is included in the GNP.
(iv) Government expenditure on goods and services: The expenditure incurred by the
government on goods and services is a part of the GNP. Central, state or local governments
spend a lot on their employees, police and army. To run the offices, the governments have also
to spend on contingencies which include paper, pen, pencil and various types of stationery,
cloth, furniture, cars, etc. It also includes the expenditure on government enterprises. But
expenditure on transfer payments is not added, because these payments are not made in
exchange for goods and services produced during the current year.
Thus GNP according to the Expenditure Method=Private Consumption Expenditure (C) +
Gross Domestic Private Investment (I) + Net Foreign Investment (X-M) + Government
Expenditure on Goods and Services (G) = C+ I + (X-M) + G.
3. Value Added Method to GNP:
Another method of measuring GNP is by value added. In calculating GNP, the money value of
final goods and services produced at current prices during a year is taken into account. This is
one of the ways to avoid double counting. But it is difficult to distinguish properly between a
final product and an intermediate product.
For instance, raw materials, semi-finished products, fuels and services, etc. are sold as inputs
by one industry to the other. They may be final goods for one industry and intermediate for
others. So, to avoid duplication, the value of intermediate products used in manufacturing final
products must be subtracted from the value of total output of each industry in the economy.
Thus, the difference between the value of material outputs and inputs at each stage of
production is called the value added. If all such differences are added up for all industries in
the economy, we arrive at the GNP by value added. GNP by value added = Gross value added
+ net income from abroad.
GNP at Market Prices:
When we multiply the total output produced in one year by their market prices prevalent during
that year in a country, we get the Gross National Product at market prices. Thus GNP at market
prices means the gross value of final goods and services produced annually in a country plus
net income from abroad. It includes the gross value of output of all items from (1) to (4)
mentioned under GNP. GNP at Market Prices = GDP at Market Prices + Net Income from
Abroad.
Now the general price level of the year for which real GDP is to be calculated is related to the
base year on the basis of the following formula which is called the deflator index:
Suppose 1990-91 is the base year and GDP for 1999-2000 is Rs. 6, 00,000 crores and the price
index for this year is 300.
Thus, Real GDP for 1999-2000 = Rs. 6, 00,000 x 100/300 = Rs. 2, 00,000 crores
™ Gross National Product (GNP):
GNP is the total measure of the flow of goods and services at market value resulting from
current production during a year in a country, including net income from abroad.
GNP includes four types of final goods and services:
(1) Consumers’ goods and services to satisfy the immediate wants of the people;
(2) Gross private domestic investment in capital goods consisting of fixed capital formation,
residential construction and inventories of finished and unfinished goods;
(3) Goods and services produced by the government; and
(4) Net exports of goods and services, i.e., the difference between value of exports and imports
of goods and services, known as net income from abroad.
In this concept of GNP, there are certain factors that have to be taken into consideration: First,
GNP is the measure of money, in which all kinds of goods and services produced in a country
during one year are measured in terms of money at current prices and then added together.
But in this manner, due to an increase or decrease in the prices, the GNP shows a rise or decline,
which may not be real. To guard against erring on this account, a particular year (say for
instance 1990-91) when prices be normal, is taken as the base year and the GNP is adjusted in
accordance with the index number for that year. This will be known as GNP at 1990-91 prices
or at constant prices.
Second, in estimating GNP of the economy, the market price of only the final products should
be taken into account. Many of the products pass through a number of stages before they are
ultimately purchased by consumers.
If those products were counted at every stage, they would be included many a time in the
national product. Consequently, the GNP would increase too much. To avoid double counting,
therefore, only the final products and not the intermediary goods should be taken into account.
Third, goods and services rendered free of charge are not included in the GNP, because it is
not possible to have a correct estimate of their market price. For example, the bringing up of a
child by the mother, imparting instructions to his son by a teacher, recitals to his friends by a
musician, etc.
4 2
GNP at Factor Cost:
GNP at factor cost is the sum of the money value of the income produced by and accruing to
the various factors of production in one year in a country. It includes all items mentioned above
under income method to GNP less indirect taxes.
GNP at market prices always includes indirect taxes levied by the government on goods which
raise their prices. But GNP at factor cost is the income which the factors of production receive
in return for their services alone. It is the cost of production.
Thus GNP at market prices is always higher than GNP at factor cost. Therefore, in order to
arrive at GNP at factor cost, we deduct indirect taxes from GNP at market prices. Again, it
often happens that the cost of production of a commodity to the producer is higher than a price
of a similar commodity in the market.
In order to protect such producers, the government helps them by granting monetary help in
the form of a subsidy equal to the difference between the market price and the cost of
production of the commodity. As a result, the price of the commodity to the producer is reduced
and equals the market price of similar commodity. For example if the market price of rice is
Rs. 3 per kg but it costs the producers in certain areas Rs. 3.50. The government gives a subsidy
of 50 paisa per kg to them in order to meet their cost of production. Thus in order to arrive at
GNP at factor cost, subsidies are added to GNP at market prices.
GNP at Factor Cost = GNP at Market Prices – Indirect Taxes + Subsidies.
™ Per Capita Income:
The average income of the people of a country in a particular year is called Per Capita Income
for that year. This concept also refers to the measurement of income at current prices and at
constant prices. For instance, in order to find out the per capita income for 2001, at current
prices, the national income of a country is divided by the population of the country in that year.
Per Capita income for a year = National Income for the year
Population in the year
Similarly, for the purpose of arriving at the Real Per Capita Income, this very formula is used.
Real Per Capita Income for a year = Real national income for the year
Population in the year
This concept enables us to know the average income and the standard of living of the people.
But it is not very reliable, because in every country due to unequal distribution of national
income, a major portion of it goes to the richer sections of the society and thus income received
by the common man is lower than the per capita income.
Methods of Measuring National Income:
There are four methods of measuring national income. Which method is to be used depends on
the availability of data in a country and the purpose in hand.
8 6
On the other hand, in one of the reports of United Nations, national income has been defined
on the basis of the systems of estimating national income, as net national product, as addition
to the shares of different factors, and as net national expenditure in a country in a year’s time.
In practice, while estimating national income, any of these three definitions may be adopted,
because the same national income would be derived, if different items were correctly included
in the estimate.
Concepts of National Income:
™ Gross Domestic Product (GDP):
GDP is the total value of goods and services produced within the country during a year. This
is calculated at market prices and is known as GDP at market prices. Dernberg defines GDP at
market price as “the market value of the output of final goods and services produced in the
domestic territory of a country during an accounting year.”
There are three different ways to measure GDP:
Product Method, Income Method and Expenditure Method.
1. The Product Method:
In this method, the value of all goods and services produced in different industries during the
year is added up. This is also known as the value added method to GDP or GDP at factor cost
by industry of origin. The following items are included in India in this: agriculture and allied
services; mining; manufacturing, construction, electricity, gas and water supply; transport,
communication and trade; banking and insurance, real estates and ownership of dwellings and
business services; and public administration and defence and other services (or government
services). In other words, it is the sum of gross value added.
2. The Income Method:
The people of a country who produce GDP during a year receive incomes from their work.
Thus GDP by income method is the sum of all factor incomes: Wages and Salaries
(compensation of employees) + Rent + Interest + Profit.
3. Expenditure Method:
This method focuses on goods and services produced within the country during one year.
GDP by expenditure method includes:
(1) Consumer expenditure on services and durable and non-durable goods (C)
(2) Investment in fixed capital such as residential and non-residential building, machinery, and
inventories (I)
(3) Government expenditure on final goods and services (G)
(4) Export of goods and services produced by the people of country (X)
(5) Less imports (M). That part of consumption, investment and government expenditure which
is spent on imports is subtracted from GDP. Similarly, any imported component, such as raw
materials, which is used in the manufacture of export goods, is also excluded.
(iii) Interest: Under interest comes the income by way of interest received by the individual
of a country from different sources. To this is added, the estimated interest on that private
capital which is invested and not borrowed by the businessman in his personal business. But
the interest received on governmental loans has to be excluded, because it is a mere transfer of
national income.
(iv) Dividends: Dividends earned by the shareholders from companies are included in the
GNP.
(v) Undistributed corporate profits: Profits which are not distributed by companies and are
retained by them are included in the GNP.
(vi) Mixed incomes: These include profits of unincorporated business, self-employed persons
and partnerships. They form part of GNP.
(vii) Direct taxes: Taxes levied on individuals, corporations and other businesses are included
in the GNP.
(viii) Indirect taxes: The government levies a number of indirect taxes, like excise duties and
sales tax. These taxes are included in the price of commodities. But revenue from these goes
to the government treasury and not to the factors of production. Therefore, the income due to
such taxes is added to the GNP.
(ix) Depreciation: Every corporation makes allowance for expenditure on wearing out and
depreciation of machines, plants and other capital equipment. Since this sum also is not a part
of the income received by the factors of production, it is, therefore, also included in the GNP
.
(x) Net income earned from abroad: This is the difference between the value of exports of
goods and services and the value of imports of goods and services. If this difference is positive,
it is added to the GNP and if it is negative, it is deducted from the GNP.
Thus GNP according to the Income Method = Wages and Salaries + Rents + Interest +
Dividends + Undistributed Corporate Profits + Mixed Income + Direct Taxes + Indirect Taxes
+ Depreciation + Net Income from abroad.
2. Expenditure Method to GNP:
From the expenditure view point, GNP is the sum total of expenditure incurred on goods and
services during one year in a country. It includes the following items:
(i) Private consumption expenditure: It includes all types of expenditure on personal
consumption by the individuals of a country. It comprises expenses on durable goods like
watch, bicycle, radio, etc., expenditure on single-used consumers’ goods like milk, bread, ghee,
clothes, etc., as also the expenditure incurred on services of all kinds like fees for school,
doctor, lawyer and transport. All these are taken as final goods.
(ii) Gross domestic private investment: Under this comes the expenditure incurred by private
enterprise on new investment and on replacement of old capital. It includes expenditure on
house construction, factory- buildings, and all types of machinery, plants and capital
equipment.
(1) Product Method:
According to this method, the total value of final goods and services produced in a country
during a year is calculated at market prices. To find out the GNP, the data of all productive
activities, such as agricultural products, wood received from forests, minerals received from
mines, commodities produced by industries, the contributions to production made by transport,
communications, insurance companies, lawyers, doctors, teachers, etc. are collected and
assessed at market prices. Only the final goods and services are included and the intermediary
goods and services are left out.
(2) Income Method:
According to this method, the net income payments received by all citizens of a country in a
particular year are added up, i.e., net incomes that accrue to all factors of production by way of
net rents, net wages, net interest and net profits are all added together but incomes received in
the form of transfer payments are not included in it. The data pertaining to income are obtained
from different sources, for instance, from income tax department in respect of high income
groups and in case of workers from their wage bills.
(3) Expenditure Method:
According to this method, the total expenditure incurred by the society in a particular year is
added together and includes personal consumption expenditure, net domestic investment,
government expenditure on goods and services, and net foreign investment. This concept is
based on the assumption that national income equals national expenditure.
(4) Value Added Method:
Another method of measuring national income is the value added by industries. The difference
between the value of material outputs and inputs at each stage of production is the value added.
If all such differences are added up for all industries in the economy, we arrive at the gross
domestic product.
Difficulties or Limitations in Measuring National Income
There are many conceptual and statistical problems involved in measuring national income by
the income method, product method, and expenditure method.
(A) Problems in Income Method:
The following problems arise in the computation of National Income by income method:
1. Owner-occupied Houses: A person who rents a house to another earns rental income, but
if he occupies the house himself, will the services of the house-owner be included in national
income. The services of the owner-occupied house are included in national income as if the
owner sells to himself as a tenant its services.
For the purpose of national income accounts, the amount of imputed rent is estimated as the
sum for which the owner-occupied house could have been rented. The imputed net rent is
calculated as that portion of the amount that would have accrued to the house-owner after
deducting all expenses.
2. Self-employed Persons: Another problem arises with regard to the income of self-employed
persons. In their case, it is very difficult to find out the different inputs provided by the owner
himself. He might be contributing his capital, land, labour and his abilities in the business. But
it is not possible to estimate the value of each factor input to production. So he gets a mixed
9 11
investment expenditure. But expenses on defence equipment are treated as consumption
expenditure because they are consumed during a war as they are destroyed or become obsolete.
However, all such expenses including the salaries of armed personnel are included in national
income.
Importance of National Income Analysis
1. For the Economy: National income data are of great importance for the economy of a
country. These days the national income data are regarded as accounts of the economy, which
are known as social accounts. These refer to net national income and net national expenditure,
which ultimately equal each other.
Social accounts tell us how the aggregates of a nation’s income, output and product result from
the income of different individuals, products of industries and transactions of international
trade. Their main constituents are inter-related and each particular account can be used to verify
the correctness of any other account.
2. National Policies: National income data form the basis of national policies such as
employment policy, because these figures enable us to know the direction in which the
industrial output, investment and savings, etc. change, and proper measures can be adopted to
bring the economy to the right path.
3. Economic Planning: In the present age of planning, the national data are of great
importance. For economic planning, it is essential that the data pertaining to a country’s gross
income, output, saving and consumption from different sources should be available. Without
these, planning is not possible.
4. Economic Models: The economists propound short-run as well as long-run economic
models or long-run investment models in which the national income data are very widely used.
5. Research: The national income data are also made use of by the research scholars of
economics. They make use of the various data of the country’s input, output, income, saving,
consumption, investment, employment, etc., which are obtained from social accounts.
6. Per Capita Income: National income data are significant for a country’s per capita income
which reflects the economic welfare of the country. The higher the per capita income, the
higher the economic welfare of the country.
7. Distribution of Income: National income statistics enable us to know about the distribution
of income in the country. From the data pertaining to wages, rent, interest and profits, we learn
of the disparities in the incomes of different sections of the society. Similarly, the regional
distribution of income is revealed.
It is only on the basis of these that the government can adopt measures to remove the
inequalities in income distribution and to restore regional equilibrium. With a view to removing
these personal and regional disequibria, the decisions to levy more taxes and increase public
expenditure also rest on national income statistics.
13
companies were started for the first time. Now they are simply financial transactions and
represent claims.
But the commission or fees charged by the brokers in the repurchase and resale of old shares,
bonds, houses, cars or scooters, etc. are included in national income. For these are the payments
they receive for their productive services during the year.
4. Illegal Activities: Income earned through illegal activities like gambling, smuggling, illicit
extraction of wine, etc. is not included in national income. Such activities have value and satisfy
the wants of the people but they are not considered productive from the point of view of society.
But in countries like Nepal and Monaco where gambling is legalised, it is included in national
income. Similarly, horse-racing is a legal activity in England and is included in national
income.
5. Consumers’ Service:
There are a number of persons in society who render services to consumers but they do not
produce anything tangible. They are the actors, dancers, doctors, singers, teachers, musicians,
lawyers, barbers, etc. The problem arises about the inclusion of their services in national
income since they do not produce tangible commodities. But as they satisfy human wants and
receive payments for their services, their services are included as final goods in estimating
national income.
6. Capital Gains: The problem also arises with regard to capital gains. Capital gains arise
when a capital asset such as a house, some other property, stocks or shares, etc. is sold at higher
price than was paid for it at the time of purchase. Capital gains are excluded from national
income because these do not arise from current economic activities. Similarly, capital losses
are not taken into account while estimating national income.
7. Inventory Changes: All inventory changes (or changes in stocks) whether positive or
negative are included in national income. The procedure is to take changes in physical units of
inventories for the year valued at average current prices paid for them.
The value of changes in inventories may be positive or negative which is added or subtracted
from the current production of the firm. Remember, it is the change in inventories and not total
inventories for the year that are taken into account in national income estimates.
8. Depreciation: Depreciation is deducted from GNP in order to arrive at NNP. Thus
depreciation lowers the national income. But the problem is of estimating the current
depreciated value of, say, a machine, whose expected life is supposed to be thirty years. Firms
calculate the depreciation value on the original cost of machines for their expected life. This
does not solve the problem because the prices of machines change almost every year.
9. Price Changes: National income by product method is measured by the value of final goods
and services at current market prices. But prices do not remain stable. They rise or fall. When
the price level rises, the national income also rises, though the national production might have
fallen.
On the contrary, with the fall in the price level, the national income also falls, though the
national production might have increased. So price changes do not adequately measure national
income. To solve this problem, economists calculate the real national income at a constant price
level by the consumer price index.
™ Types of Taxes: There are mainly two types of Taxes, direct tax and indirect tax which
are governed by two different boards, Central Board of Direct Taxes (CBDT) and
Central Board of Excise and Customs (CBEC).
1) Direct Taxes
Direct taxes are the personal liability of tax payer. These are collected directly from the tax
payers and they have to be paid by the persons on whom it is imposed. Important direct taxes
are:
x Income Tax
x Wealth Tax
x Property Tax/Capital Gains Tax
x Gift Tax/ Inheritance or Estate Tax
x Corporate Tax
2) Indirect Tax
Impact and incidence of indirect Taxes fall on different persons as opposed to direct taxes
where impact and incidence is on the same person. These taxes are recovered from different
groups of people but the liability remains with the person who collects it. Tax payer recovers
the indirect taxes paid from their consumers and clients and finally pays it to government. For
example, when we purchase any product we pay VAT, when we eat in restaurants we pay
service tax which are ultimately deposited in government's kitty by the service providers.
Various types of indirect taxes are:
x Service Tax
x Custom Duty
x Excise Duty
x Sales Tax and VAT
x Security Transaction Tax
Taxation
A means by which governments finance their expenditure by imposing charges on citizens
and corporate entities.
Governments use taxation to encourage or discourage certain economic decisions. For
example, reduction in taxable personal (or household) income by the amount paid as interest
on home mortgage loans results in greater construction activity, and generates more jobs.
Objectives of Taxation:
The primary purpose of taxation is to raise revenue to meet huge public expenditure. Most
governmental activities must be financed by taxation. But it is not the only goal. In other words,
taxation policy has some non-revenue objectives. In the modern world, taxation is used as an
instrument of economic policy. It affects the total volume of production, consumption,
investment, choice of industrial location and techniques, balance of payments, distribution of
income, etc. Some of the objectives of taxation are:
15

(C) Problems in Expenditure Method:
The following problems arise in the calculation of national income by expenditure method:
(1) Government Services: In calculating national income by, expenditure method, the problem
of estimating government services arises. Government provides a number of services, such as
police and military services, administrative and legal services. Should expenditure on
government services be included in national income?
If they are final goods, then only they would be included in national income. On the other hand,
if they are used as intermediate goods, meant for further production, they would not be included
in national income. There are many divergent views on this issue.
One view is that if police, military, legal and administrative services protect the lives, property
and liberty of the people, they are treated as final goods and hence form part of national income.
If they help in the smooth functioning of the production process by maintaining peace and
security, then they are like intermediate goods that do not enter into national income.
In reality, it is not possible to make a clear demarcation as to which service protects the people
and which protects the productive process. Therefore, all such services are regarded as final
goods and are included in national income.
(2) Transfer Payments: There arises the problem of including transfer payments in national
income. Government makes payments in the form of pensions, unemployment allowance,
subsidies, interest on national debt, etc. These are government expenditures but they are not
included in national income because they are paid without adding anything to the production
process during the current year.
For instance, pensions and unemployment allowances are paid to individuals by the
government without doing any productive work during the year. Subsidies tend to lower the
market price of the commodities. Interest on national or public debt is also considered a transfer
payment because it is paid by the government to individuals and firms on their past savings
without any productive work.
(3) Durable-use Consumers’ Goods: Durable-use consumers’ goods also pose a problem.
Such durable-use consumers’ goods as scooters, cars, fans, TVs, furniture’s, etc. are bought in
one year but they are used for a number of years. Should they be included under investment
expenditure or consumption expenditure in national income estimates? The expenditure on
them is regarded as final consumption expenditure because it is not possible to measure their
used up value for the subsequent years.
But there is one exception. The expenditure on a new house is regarded as investment
expenditure and not consumption expenditure. This is because the rental income or the imputed
rent which the house-owner gets is for making investment on the new house. However,
expenditure on a car by a household is consumption expenditure. But if he spends the amount
for using it as a taxi, it is investment expenditure.
(4) Public Expenditure: Government spends on police, military, administrative and legal
services, parks, street lighting, irrigation, museums, education, public health, roads, canals,
buildings, etc. The problem is to find out which expenditure is consumption expenditure and
which investment expenditure is.
Expenses on education, museums, public health, police, parks, street lighting, civil and judicial
administration are consumption expenditure. Expenses on roads, canals, buildings, etc. are
12
Economic Development: One of the important objectives of taxation is economic
development. Economic development of any country is largely conditioned by the growth of
capital formation. It is said that capital formation is the kingpin of economic development. To
overcome the scarcity of capital, governments of these countries mobilize resources so that a
rapid capital accumulation takes place. To step up both public and private investment,
government taps tax revenues. Through proper tax planning, the ratio of savings to national
income can be raised.
Full Employment: Second objective is the full employment. Since the level of employment
depends on effective demand, a country desirous of achieving the goal of full employment must
cut down the rate of taxes. Consequently, disposable income will rise and, hence, demand for
goods and services will rise. Increased demand will stimulate investment leading to a rise in
income and employment through the multiplier mechanism.
Price Stability: Thirdly, taxation can be used to ensure price stability—a short run objective
of taxation. Taxes are regarded as an effective means of controlling inflation. By raising the
rate of direct taxes, private spending can be controlled. Naturally, the pressure on the
commodity market is reduced. But indirect taxes imposed on commodities fuel inflationary
tendencies. High commodity prices, on the one hand, discourage consumption and, on the other
hand, encourage saving. Opposite effect will occur when taxes are lowered down during
deflation.
Control of Cyclical Fluctuations: Fourthly, control of cyclical fluctuations—periods of boom
and depression—is considered to be another objective of taxation. During depression, taxes are
lowered down while during boom taxes are increased so that cyclical fluctuations are tamed.
Reduction of BOP Difficulties: Fifthly, taxes like custom duties are also used to control
imports of certain goods with the objective of reducing the intensity of balance of payments
difficulties and encouraging domestic production of import substitutes.
Non-Revenue Objective: Finally, another extra-revenue or non-revenue objective of taxation
is the reduction of inequalities in income and wealth. This can be done by taxing the rich at
higher rate than the poor or by introducing a system of progressive taxation.
Canons of Taxation
Canons of Taxation are the main basic principles (i.e. rules) set to build a 'Good Tax System'.
Canons of taxation refer to the administrative aspects of a tax. They relate to the rate, amount,
and method of levy and collection of a tax. In other words, the characteristics or qualities which
a good tax should possess are described as canons of taxation. It must be noted that canons
refer to the qualities of an isolated tax and not to the tax system as a whole. A good tax system
should have a proper combination of all kinds of taxes having different canons.
Canons of Taxation were first originally laid down by economist Adam Smith in his famous
book "The Wealth of Nations". In this book, Adam smith only gave four canons of taxation.
These original four canons are now known as the "Original or Main Canons of Taxation".
16
income consisting of interest, rent, wage and profits for his factor services. This is included in
national income.
3. Goods meant for Self-consumption: In under-developed countries like India, farmers keep
a large portion of food and other goods produced on the farm for self-consumption. The
problem is whether that part of the produce which is not sold in the market can be included in
national income or not. If the farmer were to sell his entire produce in the market, he will have
to buy what he needs for self-consumption out of his money income. If, instead he keeps some
produce for his self-consumption, it has money value which must be included in national
income.
4. Wages and Salaries paid in Kind: Another problem arises with regard to wages and salaries
paid in kind to the employees in the form of free food, lodging, dress and other amenities.
Payments in kind by employers are included in national income. This is because the employees
would have received money income equal to the value of free food, lodging, etc. from the
employer and spent the same in paying for food, lodging, etc.
(B) Problems in Product Method:
The following problems arise in the computation of national income by product method:
1. Services of Housewives:
The estimation of the unpaid services of the housewife in the national income presents a serious
difficulty. A housewife renders a number of useful services like preparation of meals, serving,
tailoring, mending, washing, cleaning, bringing up children, etc. She is not paid for them and
her services are not including in national income. Such services performed by paid servants are
included in national income. The national income is, therefore, underestimated by excluding
the services of a housewife.
The reason for the exclusion of her services from national income is that the love and affection
of a housewife in performing her domestic work cannot be measured in monetary terms. That
is why when the owner of a firm marries his lady secretary, her services are not included in
national income when she stops working as a secretary and becomes a housewife. When a
teacher teaches his own children, his work is also not included in national income. Similarly,
there are a number of goods and services which are difficult to be assessed in money terms for
the reason stated above, such as painting, singing, dancing, etc. as hobbies.
2. Intermediate and Final Goods: The greatest difficulty in estimating national income by
product method is the failure to distinguish properly between intermediate and final goods.
There is always the possibility of including a good or service more than once, whereas only
final goods are included in national income estimates. This leads to the problem of double
counting which leads to the overestimation of national income.
3. Second-hand Goods and Assets: Another problem arises with regard to the sale and
purchase of second-hand goods and assets. We find that old scooters, cars, houses, machinery,
etc. are transacted daily in the country. But they are not included in national income because
they were counted in the national product in the year they were manufactured.
If they are included every time they are bought and sold, national income would increase many
times. Similarly, the sale and purchase of old stocks, shares, and bonds of companies are not
included in national income because they were included in national income when the
10
Taxation- Canons of Taxation
Tax
The tax revenue is the most important source of public revenue. A tax is a compulsory payment
levied by the government on individuals or companies to meet the expenditure which is
required for public welfare.
According to Hugh Dalton, "a tax is a compulsory contribution imposed by a public authority,
irrespective of the exact amount of service rendered to the taxpayer in return, and not imposed
as penalty for any legal offence."
™ Tax is a payment made to the government of a country without “quid pro quo”i.e.
nothing in return
™ The authority to tax is derived by the government from the constitution of the country.-
i.e. Article 265 of the INDIAN CONSTITUTION.
™ It states that no tax shall be levied or collected by the government without the authority
of law.
™ India has a well-developed tax structure with a three-tier federal structure, comprising
the Union Government, the State Governments and the Urban/Rural Local Bodies. The
power to levy taxes and duties is distributed among the three tiers of Governments, in
accordance with the provisions of the Indian Constitution
™ Income tax is today an important source of revenue for government in all the countries.
™ More than 3,000 years ago, the inhabitants of ancient Egypt and Greece used to pay income
tax, consumption taxes and custom duties.
™ Income-tax was first introduced in India in 1860 by James Wilson who become India’s first
finance member.
™ Income-tax Authorities.
Central government: - income-tax, excise duty and customs duty.
State government: - sales tax, vat, excise and tax on agricultural income.
Municipalities: - octroi and house property tax.
™ Heads of Income: According to Section 14 of Income Tax Act, 1961, the income of a
person is classified under various defined heads of income. Thus, for the purpose
of computation of total income, the income is first categorized under the heads of
income and then charged to Income Tax in accordance with the provisions and rules as
specified in the Income Tax Act.
The five heads of income according to section 14 for computation of income tax in India are
as follows:
x Income from Salary
x Income from House Property
x Income from Profits and Gains of Business or Profession
x Income from Capital Gains
x Income From Other Sources
14
As the time changed, governance expanded and became much more complex than what it was
at the Adam Smith's time. Soon a need was felt by modern economists to expand Smith's
principles of taxation and as a response they put forward some additional modern canons of
taxation.
According to Adam Smith, there are four canons or maxims of taxation on the administrative
side of public finance which are still recognised as classic.
1. Canon of equality or equity.
2. Canon of certainty.
3. Canon of economy.
4. Canon of convenience.
To these four canons, economists like Bastable have added a few more which are as under:
5. Canon of elasticity.
6. Canon of flexibility
7. Canon of productivity.
8. Canon of simplicity.
9. Canon of diversity.
10. Canon of expediency
Canon of Equality:
Every fiscal economist, along with Adam Smith, stresses that taxation must ensure justice. The
canon of equality or equity implies that the burden of taxation must be distributed equally or
equitably in relation to the ability of the tax payers. Equity or social justice demands that the
rich people should bear a heavier burden of tax and the poor a lesser burden. Hence, a tax
system should contain progressive tax rates based on the tax-payer’s ability to pay and sacrifice.
Canon of Certainty:
Taxation must have an element of certainty. According to Adam Smith, “the tax which each
individual is bound to pay ought to be certain and not arbitrary. The time of payment, the
manner of payment, the amount to be paid ought to be clear and plain to the contributor and to
every other person.”
The certainty aspects of taxation are:
1. Certainty of effective incidence i.e., who shall bear the tax burden.
2. Certainty of liability as to how much shall be the tax amount payable in a particular period.
This the tax payers as well as the exchequer should unambiguously know.
3. Certainty of revenue i.e., the government should be certain about the estimated collection of
revenue from a given tax levied.
17
be insufficient for raising loans against their security. This reduces the scope of business
growth.
(iii) Unlimited liability: The sole proprietor is personally liable for all business obligations.
For payment of business debts, his personal property can also be used if the business assets are
insufficient.
(iv) Lack of continuity: A sole proprietary organisation suffers from lack of continuity. If the
proprietor is ill this may cause temporary closure of business. And if he dies the business may
be permanently closed. From the above account of the merits and limitations it becomes clear
that it is only personal services like repair work, tailoring etc. small factories, retail shops and
professional activities which can be set up as sole proprietary organisations. In India, this form
of organisation is quite popular and accounts for the largest number of business units.
Partnership
Partnership is an association of persons who agree to combine their financial resources and
managerial abilities to run a business and share profits in an agreed ratio. Since the resources
of a sole proprietor to finance, and his capacity to manage a growing business is limited, he
feels the need for a partnership firm. Partnership business, therefore, usually grows out of the
need for expansion of business with more capital, better supervision and control, division of
work and spreading of risks.
The Indian Partnership Act defines partnership as “Partnership” is the relation between
persons who have agreed to share the profits of a business carried on by all or any one of
them acting for all. The persons who have agreed to join in partnership are individually called
“Partners” and collectively a ‘firm’. A partnership firm can be formed with a minimum of two
partners and it can have a maximum of twenty partners.
Features of Partnership:
(i) Existence of an agreement: Partnership is formed on the basis of an agreement between
two or more persons to carry on business. It does not arise out of the operation of law as in the
case of joint Hindu family business. The terms and conditions of partnership are laid down in
a document known as Partnership Deed.
(ii) Engagement in business: A partnership can be formed only on the basis of a business
activity. Its business may include any trade, industry or profession. Thus, a partnership can
engage in any occupation - production and/or distribution of goods and services with a view to
earning profits.
(iii) Sharing of profits and losses: In a partnership firm, partners are entitled to share in the
profits and are also to bear the losses, if any.
(iv) Agency relationship: The partnership business may be carried on by all or any of the
partners acting for all. Thus, each partner is a principal and so can act in his own right. At the
same time he can act on behalf of other partners as their agent. Thus, every partner can bind
the firm by his acts.
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Requirement of a Good Tax Structure / System
The tax structure is a part of economic organisation of a society and therefore fit in its overall
economic environment. No tax system that does not satisfy these basic condition can be termed
a good one. However, the state should pursue mainly following principles in structuring its tax
system:-
x The primary aim of the tax should be to raise revenue for public services.
x People should be asked to pay taxes according to their ability to pay and assessment of
their taxable capacity should be made primarily on the basis of income and property.
x Tax should not be discriminatory in any aspect between individuals and also between
various groups.
Forms of Business Organisations
x Business organisation refers to how business is structured.
x A business organisation is an individual or group of people that collaborate to achieve
certain commercial goals.
After identifying the business in any field, it is necessary then to have a legal entity to be
known in the society. The legal entity can be in any form of a business organization. The
various forms of organization are as follows:
1) Sole proprietorship
2) Partnership
3) Co-operative Society
4) Joint stock company (Private and Public)
Sole proprietorship
The sole proprietorship is a form of business that is owned, managed and controlled by an
individual. He has to arrange capital for the business and he alone is responsible for its
management. He is therefore, entitled to the profits and has to bear the loss of business,
however, he can take the help of his family members and also make use of the services of others
such as a manager and other employees. This type of business organisation is also called single
ownership or single proprietorship. If the business primarily consists of trade, the organization
is a sole trading organization. Small factories and shops are often found to be sole
proprietorship organisations. It is the simplest and most easily formed business organization.
This is because not much legal formality is required to establish it. For instance to start a factory
the permission of the local authorities is sufficient. Similarly to start a restaurant, it is only
necessary to get the permission of local health authorities. Or again, to run a grocery store, the
proprietor has only to follow the rules laid down by local administration
Features of Sole Proprietorship:
The important features of a sole-proprietary organization include the following:
(i) Individual Initiative: One person is the owner in a sole proprietary form of organisation.
(ii) Risk Bearing: The proprietor is the sole beneficiary of profits in this form organisation. If
there is a loss he alone has to bear it. Thus the risks of business are borne by the proprietor
himself.
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during its existence. A partnership firm desiring registration applies lo the Registrar of Firms
in prescribed form along with the registration fee. The application should state the following:
x Name of the firm.
x The principal place of business of the firm.
x The name of any other place where the firm is to carry on business:
x Date of admission of the partners in the firm.
x Names and permanent addresses of the partners.
x Duration of the firm.
The application shall be signed and verified by each partner. Changes in the above particulars
have to be communicated to the Registrar. The Certificate of registration is reliable evidence
and a conclusive proof of the existence of the firm.
Consequences of Non-Registration:
An unregistered firm suffers from the following serious disabilities:
x A partner of an unregistered firm cannot file a suit against the firm or any other partner
for enforcing his right arising out of the contract;
x ii) An unregistered firm cannot file suit against any third party for the recovery of the
claims;
x Such a firm also cannot file a suit against any partner.
Types of Partnership
According to the nature of agreement among partners, there can be three types of partnership
as follows:
x Partnership at-will: Such a partnership exists on the will of the partners. That is, it can
be brought to an end whenever any partner gives notice of his intention to do so.
x Particular partnership: A particular partnership is formed for undertaking a particular
venture. It comes to an end automatically with completion of the venture.
x Partnership for a fixed duration: Such partnership is for a fixed period of time say 2
years, 5 years or any other duration.
Types of Partners
The various types of partner found in partnership firms are as follows:
(i) Active Partners: Partners who take active part in the conduct of day-to-day business of the
firm are called active partners. These partners carry on business on behalf of the other partners.
(ii) Sleeping or dormant partners: Sleeping or dormant partners are those who do not take
active part in the management of the business. Such partners only contribute capital in the firm
and are bound by the activities of other partners. However, they share in the profits and losses
of the business.
23
(iii) Management and control: Management and control of this type of organisation is the
responsibility of the sole proprietor. He may, however, employ a manager or other people for
the purpose.
(iv) Minimum government regulations: The government does not interfere with the working
of the sole proprietorship organisation. However, they have to comply with the general laws
and rules laid down by government.
(v) Unlimited liability: The sole proprietor has to bear the losses and is responsible for the
liabilities of the business. If the business assets are not sufficient to meet the liabilities, he may
also have to sell his personal property for that purpose.
(vi) Secrecy: All important decision taken by the owner himself. He keeps all the business
secrets only to himself.
Merits of Sole Proprietorship:
(i) Easy formation: A sole proprietorship business is easy to form where no legal formality
involved in setting up this type of organization. It is not governed by any specific law. It is
simply required that the business activity should be lawful and should comply with the rules
and regulations laid down by local authorities.
(ii) Better Control: In sole proprietary organisation, all the decisions relating to business
operations are taken by one person, which makes functioning of business simple and easy. The
sole proprietor can also bring about changes in the size and nature of activity. This gives better
control to business.
(iii) Sole beneficiary of profits: The sole proprietor is the only person to whom the profits
belong. There is a direct relation between effort and reward. This motivates him to work hard
and bear the risks of business.
(iv) Benefits of small-scale operations: The sole proprietorship is generally organized for
small-scale business. This helps the proprietor’s family members to be employed in business.
At the same time such a business is also entitled to certain concessions from the government.
For example, small industrial organisations can get electricity and water supply at concessional
rates on a priority basis.
(v) Inexpensive Management: The sole proprietor does not appoint any specialists for various
functions. He personally supervises various activities and can avoid wastage in the business.
Limitations of Sole Proprietorship:
(i) Limitation of management skills: A sole proprietor may not be able to manage the
business efficiently as he is not likely to have necessary skills regarding all aspects of the
business. This poses difficulties in the growth of business also.
(ii) Limitation of Resources: The sole proprietor of a business is generally at a disadvantage
in raising sufficient capital. His own capital may be limited and his personal assets may also
20
(iii) Others: Active and sleeping partners are, as a matter of fact, the full-fledged partners i.e.
they share in profits and losses of the business and are liable for its dues. However, there are
other types of partners also who may be associated with partnership directly or indirectly. They
are not full-fledged partners, such partners may include the following:
(a) Nominal Partners: Nominal partners are those who do not have interest in the business
but lend their name to the firm. They do not make any capital contribution, and are not entitled
to take part in management, but are liable, like other partners, to third parties. Such partners
generally have a pecuniary interest (like a share in the profits) in lending their name to a firm.
However in certain cases they may not have any pecuniary interest in doing so. For example,
a reputed industrialist may, without any profit motive lend his name to a firm run by his family
members.
(b) Partners by holding out: If a person by his words or conduct holds out to another that he
is a partner, he will be prevented from denying that he is not a partner. The person who thus
becomes liable to third parties to pay the debts of the firm is known as a partner by holding out.
Merits of Partnership
(i) Ease in formation: A partnership is very easy to form. All that is required is an agreement
among the partners. Even the expenses to be incurred for registration are-not much.
(ii) Pooling of financial resources: A partnership commands more financial resources
compared to sole proprietorship. This helps in expanding business and earning more profits.
As and when a firm requires more money, more partners can be admitted.
(iii) Pooling of managerial skills: A partnership facilitates pooling of managerial skills of all
its partners. This leads to greater efficiency in business operations. For instance, in a big
partnership firm, one partner can handle production function, another partner can look after all
marketing activity, still another can attend to legal and personnel problems, and so on.
(iv) Balanced business decisions: In a partnership firm, decisions are taken unanimously after
considering all the major aspects of a problem. This ensures not only balanced business
decisions but also removes difficulties in the smooth implementation of those decisions.
(v) Sharing of risks: Unlike sole proprietary organisation, the risks of partnership business are
shared by partners on a predetermined basis. This encourages partners to undertake risky but
profitable business activities.
Limitations of Partnership
(i) Uncertainty of existence: The existence of a partnership firm is very uncertain. The
retirement, death, bankruptcy or lunacy of any partner can put an end to the partnership.
Further, the partnership business can come to a close if any partner demands it.
(ii) Risks of implied authority: It is true that like the sole proprietor each partner has unlimited
liability. But his liability may arise not only from his own acts but also from the acts and
mistakes of co-partners over whom he has no control. This discourages many persons with
money and ability, to join a partnership firm as partner.
24
Canon of Economy:
This principle suggests that the cost of collecting a tax should not be exorbitant but be the
minimum. Extravagant tax collection machinery is not justified. According to Adam Smith,
“Every tax has to be contrived as both to take and keep out of the pockets of the people as little
as possible over and above what it brings into the public treasury of the state.”
Owing to the complex and ever-changing nature of taxation laws in India, government has to
maintain elaborate tax collection machinery with a large staff of highly trained personnel
involving high administrative costs and inordinate delay in assessment and collection of tax.
Canon of Convenience:
According to this canon, tax should be collected in a convenient manner from the tax payers.
Adam Smith stresses: “Every tax ought to be levied at the time or in the manner in which it is
most likely to be convenient for the contributor to pay it.” For example, it is convenient to pay
a tax when it is deducted at source from the salaried classes at the time of paying salaries.
Canon of Elasticity:
According to this canon, every tax imposed by the government should be elastic in nature. In
other words, the income from tax should be capable of increasing or decreasing according to
the requirement of the country. For example, if the government needs more income at time of
crisis, the tax should be capable of yielding more income through increase in its rate.
Canon of Flexibility
It should be easily possible for the authorities to revise the tax structure both with respect to
its coverage and rates, to suit the changing requirements of the economy. With changing time
and conditions the tax system needs to be changed without much difficulty. The tax system
must be flexible and not rigid.
Canon of Productivity:
This implies that a tax must yield sufficient revenue and not adversely affect production in the
economy.
Canon of Simplicity:
This norm suggests that tax rates and tax systems ought to be simple and comprehensible and
not to be complex and beyond the understanding of the layman. This is what is rarely found in
the Indian tax structure.
Canon of Diversity:
Canon of diversity implies that there should be a multiple tax system of diverse nature rather
than having a single tax system. In the former case, the tax payer will not be burdened with a
high incidence of tax in the aggregate.
Canon of Expediency:
This suggests that a tax should be determined on the ground of its economic, social and political
expediency. For instance, a tax on agricultural income lacks social, political or administrative
expediency in India and that is why the government of India had to discontinue it.
18
(v) Unlimited Liability: The liability of partners is unlimited as in the case of sole
proprietorship. In case some obligation arises then not only the partnership assets but also the
private property of the partners can be taken for the payment of liabilities of the firm.
(vi) Common Management: Every partner has a right to take part in the running of the
business. It is not necessary for all partners to participate in the day-to-day activities of the
business but they are entitled to participate. Even if partnership business is run by some
partners, the consent of all other partners is necessary for taking important decisions.
(vii) Restriction on transferability of share: No partner can transfer his share in partnership
to any other person. He may, however, do so with the consent of all other partners.
(viii) Registration: To form a partnership firm, it is not compulsory to register it. However, if
the partners so decide, it may be registered with the Registrar of Firms. There are advantages
of registration, which are discussed later.
(ix) Duration: The partnership firm continues at the pleasure of the partners. Legally a
partnership comes to an end if any partner dies, retires or becomes insolvent. However, if the
remaining partners agree to work together under the original firm’s name, the firm will not be
dissolved and will continue its business after settling the claim of the outgoing partner.
Partnership Deed:
Partnership Deed lays down the terms and conditions of partnership and the rights, duties and
obligations of partners. The following points are generally covered in the Deed:
x The nature of business.
x Name of the firm and the place where its business will be carried on.
x Amount of capital to be contributed by each partner.
x Duties, powers and obligations of all the partners.
x Method of preparing accounts and arrangement for audit.
x Whether loans will be accepted from a partner over and above the capital also, if so, at
what rate of interest.
x The amount to be allowed as private drawings by each partner and the interest to be
charged thereon.
x The ratio in which profits are to be shared.
x Whether a partner can be expelled and, if so, the procedure for the same.
x Method for the settlement of disputes.
x Circumstances under which the partnership will stand dissolved, and in case of
dissolution, under whose custody the books of accounts will remain.
The Deed has to be stamped and each partner should have a copy of it.
Registration of firm: Registration of a partnership firm is not compulsory under Indian
Partnership Act. In England registration is compulsory. In India, certain privileges which are
allowed to those firms, which are registered. But an unregistered firm suffers from certain
disabilities. These disabilities make it virtually compulsory for a firm to get registered. A
partnership firm may be registered at any time. That is, at the time of formation or at any time
22
(iii) Risks of disharmony: In partnership, since decisions are taken unanimously, it is essential
that all partners reconcile their views for the common good of the organisation. But there may
arise situations when some partners may adopt rigid attitudes and make it impossible to arrive
at a commonly agreed decision. Lack of harmony may paralyse the business and cause conflict
and mutual bickering.
(iv) Difficulty in withdrawal from the firm: Investment in a partnership can be easily made
but cannot be easily withdrawn. This is so because the withdrawal of a partner’s share requires
the consent of all other partners.
(v) Lack of institutional confidence: A partnership business does not enjoy much confidence
of banks and financial institutions. It is because the nature of its activities is not disclosed at
public and the agreement among partners is not regulated by any law. As a result large financial
resources cannot be raised by partnership and growth of business cannot be ensured.
(vi) Difficulties of expansion: It is difficult for a partnership firm to undertake modernization
of expansion of its operations. This is because of its inability to raise adequate funds for the
purpose. Limited membership (restricted to 20) and their limited personal resources do not
permit large amounts of capital to be raised by the partners. Therefore, large-scale business
cannot generally be organised by partnerships.
Co-operative organisation
It is a voluntary association of persons for mutual benefit and its aims are accomplished through
self-help and collective effort.
The main principle underlying a cooperative organization is mutual help, i.e., each for one and
all for each. A minimum of 10 persons are required to form a co-operative society. To be called
a co-operative society it must be registered with the Registrar of Co-operative Societies under
the Co-operative Societies Act. The capital of a cooperative Society is raised from its members
by way of share capital. It can also obtain additional resources by way of loans from the State
and Central Co-operative Banks. A Co-operative society has much in common with
partnership, yet there are differences between the two types of organisation. In partnership,
mutual benefit is restricted to partners only, but in a co-operative society it extends to its
members as also the public.
For example in a consumer co-operative store or a co-operative credit society, the benefits are
available to the members as well as the general public. Besides, partnership requires the
existence of some business activity whereas a cooperative may be formed whenever individuals
have common needs, which are difficult to fulfil single-handed. Also, registration is optional
in the case of partnership but it is compulsory for a co-operative society
Type of Co-operative Societies: Co-operative societies may be classified into different
categories according to the nature of activities performed by them. The main types of co-
operative societies are:
x Consumers’ co-operative societies.
x Producers’ co-operative societies.
x Co-operative marketing societies.
25
limited liability i.e. liability limited by guarantee or shares. Shares of such company are easily
transferable.
A joint stock company is suitable where the volume of business is quite large, the area of
operation is widespread.
Characteristics of a Joint Stock Company
1. Artificial Person: A Joint Stock Company is an artificial person as it does not possess any
physical attributes of a natural person and it is created by law. Thus it has a legal entity separate
from its members.
2. Separate legal Entity: Being an artificial person a company has its own legal entity separate
from its members. It can own assets or property, enter into contracts, sue or can be sued by
anyone in the court of law. Its shareholders cannot be held liable for any conduct of the
company.
3. Perpetual Existence: A company once formed continues to exist as long as it is fulfilling
all the conditions prescribed by the law. Its existence is not affected by the death, insolvency
or retirement of its members.
4. Limited liability of shareholders: Shareholders of a joint stock company are only liable to
the extent of shares they hold in a company not more than that. Their liability is limited by
guarantee or shares held by them.
5. Common Seal: Being an artificial person a joint stock company cannot sign any documents
thus this common seal is the company’s representative while dealing with the outsiders. Any
document having common seal and the signature of the officer is binding on the company.
6. Transferability of Shares: Members of a joint stock company are free to transfer their
shares to anyone.
7. Capital: A joint stock company can raise large amount of capital by issuing its shares.
8. Management: A joint stock company has a democratic management which is managed by
the elected representatives of shareholders, known as directors of the company.
9. Membership: To form a private limited company minimum number of members prescribed
in the companies Act is 2 and the maximum number is 50. But in the case of public limited
company the minimum limit is 7 and no limit on maximum number of members.
10. Formation: Generally a company is formed with the initiative of group of members who
are also known as promoters but it comes into existence after completing all the formalities
prescribed in Companies Act 1956.
Advantages of joint stock company
1. Limited Liability: Liability of members of Joint Stock Company is limited to the extent of
shares held by them. Hence shareholders assets will not be on stake. This feature attracts large
number of investors to invest in the company.
2. Perpetual Existence: A company is an artificial legal person created by law which has its
own independent legal status. Its existence is not affected by the death or insolvency of its
members.
29
Characteristics of Co-operative Organisation
(i) Voluntary association: In co-operatives, the membership is voluntary. Anybody having a
common interest is free to join a co-operative society. The member can also leave the society
any time after giving proper notice.
(ii) Equal voting rights: In a co-operative society, the principle of one-man one vote is
adopted. A member has only one vote irrespective of the number of share(s) held by him. Thus,
a co-operative society is run on democratic principles.
(iii) Separate legal entity: A co-operative society is required to be registered under the Co-
operative Societies Act. Registration provides it a separate legal entity. Its existence is quite
different from its members. The death, insolvency or lunacy of a member does not affect its
existence. It can sue and be sued in its own name. It can make agreements as well as purchase
and sell properly in its own name.
(iv) Service motive: A co-operative society is based on the service motive of its members. It’s
main objective is to provide service to the members and not to maximize profits. Earning profit
is the most important objective of other forms of business organisation. It is not so in the case
of co-operatives.
(v) Distribution of surplus: Out of the profits of the cooperative, members are paid dividend
and bonus. The bonus is given according to the volume of business transacted by each member
with the co-operative society. For example, in a consumer co-operative society, bonus is paid
in proportion to the purchases made by members during a year. In producers’ co-operative the
valued goods delivered for sale form the basis of distributing bonus.
Merits of Co-operative Organisations
(i) Easy to form: A co-operative society is voluntary association and may be formed with a
minimum of ten adult members. Its registration is very simple and can be done without much
legal formalities.
(ii) Open membership: Membership in a Co-operative organisation is open to all having a
common interest. A person can become a member at any time he likes and can leave the society
by returning his shares without affecting its continuity.
(iii) Democratic management: A co-operative society is managed in a democratic manner. It
is based on principle of one man one vote. All members have equal rights and can have a voice
in its management.
(iv) Limited liability: The liability of the members of a cooperative society is limited to the
extent of capital contributed by them. They don’t have to bear personal liability for the debts
of the society.
(v) Stability: A co-operative society has a separate legal existence. It is not affected by the
death, insolvency, lunacy or permanent incapacity of any of its members. It has a fairly stable
life and continues to exist for a long period.
27
Private Limited Company
These companies can be formed by at least two individuals having minimum paid-up capital
of not less than Rupees one lakh. As per the Companies Act, 1956 the total membership of
these companies cannot exceed 50. The shares allotted to its members are also not freely
transferable between them. These companies are not allowed to raise money from the public
through open invitation. They are required to use "Private Limited" after their names. The
examples of such companies are Combined Marketing Services Private Limited, Indian
Publishers and Distributors Private Limited, Oricom Systems Private Limited, etc.
Public Limited Company
A minimum of seven members are required to form a public limited company. It must have
minimum paid-up capital of Rs 5 lakhs. There is no restriction on maximum number of
members. The shares allotted to the members are freely transferable. These companies can
raise funds from general public through open invitations by selling its shares or accepting
fixed deposits. These companies are required to write either 'public limited' or 'limited' after
their names. Examples of such companies are Hyundai Motors India Limited, Steel Authority
of India Limited, Jhandu Pharmaceuticals Limited etc.
Difference between Private Limited and Public Limited Companies:
Basis Private Limited Company Public Limited Company
Membership Minimum - 02 Minimum - 07
Maximum - 50 Maximum - no restriction
Identification Use a suffix "Private Limited" Use a suffix "Limited" after its
after its name name
Transferability of Restricted Free
shares
Capital required Not less than Rs.1 lakh Not less than Rs.5 lakh
Raising of funds Cannot give open invitation to the Can raise as much money as
public to subscribe the shares required from public
Government Company
In these companies the Government (either state or central government or both) holds a
majority share capital i.e., not less than 51%. However, companies having less than 51%
shareholding by the government can also be called Government companies provided control
and management lies with the government. Examples of government companies are:
Mahanagar Telephone Nigam Limited, Bharat Heavy Electricals Limited.
Indian Company
A company having business operations in India and registered under the Indian Companies
Act, 1956 is called Indian Company. An Indian company may be formed as a public limited,
private limited or government company.
Foreign Company
A foreign company is a company formed and registered outside India having business op-
erations in India.
31
(vi) Economical operations: The operation of co-operative society is quite economical due to
elimination of middlemen and the voluntarily services provided by its members.
(vii) Government patronage: Government gives all kind of help to co-operatives, such as
loans at lower rates of interest and relief in taxation.
(viii)Other benefits: Certain non-economic benefits are also derived by members through
cooperatives. Credit cooperatives, for instance, promote habits of thrift and producers’ co-
operative encourage joint activity among members.
Limitations of Co-operative Organisations
(i) Limited capital: Co-operatives are usually at a disadvantage in raising capital because of
the low rate of return on capital invested by members.
(ii) Inefficient management: The management of a cooperative society is generally inefficient
because the managing committee consists of part-time and inexperienced people. Qualified
managers are not attracted towards a co-operative on account of its limited capacity to pay
adequate remuneration.
(iii) Absence of motivation: A co-operative society is formed for mutual benefit and the
interest of individual members are not fully satisfied. There is no direct link between effort and
reward. Hence members are not inclined to put in their best efforts in a co-operative society.
(iv) Differences and factionalism among members: Once the initial enthusiasm about the
co-operative ideal is exhausted, differences and group conflicts arise among members. Then it
becomes very difficult to get full cooperation of the members. The selfish motives of members
begin to dominate and service motive is sometimes forgotten. But the society continues because
it functions in the interest of members.
(v) Rigid rules and regulations: Excessive government regulation and control over Co-
operatives affect their functioning. For example, a Co-operative society is required to get its
accounts audited by the auditors of the co-operative department and submit its accounts
regularly to the Registrar. These regulations and control may adversely affect the flexibility of
operations and the efficiency of management in a co-operative society.
Joint Stock Company
According to Prof. Haney,"Joint Stock Company is a voluntary association of individuals for
profit, having their capital divided into transferable shares, the ownership of which is the
condition for membership". Thus, a joint stock company is an incorporated association of
persons having a separate legal existence, with a perpetual succession and common seal.
A Joint Stock Company is a voluntary association of persons to carry on the business. It is an
association of persons who contribute money which is called capital for some common
purpose. These persons are members of the company. The proportion of capital to which each
member is entitled is his share and every member holding such share is called shareholders and
the capital of the company is known as share capital. The Companies Act 1956 defines a joint
stock company as an artificial person created by law, having separate legal entity from its owner
with perpetual succession and a common seal. Shareholders of Joint Stock Company have
28
Indian Economy- Overview of post-independence period
Historical background of Indian economy
The British came to India in the year 1600 as traders of the East India Company. During the
British rule in India, Government Policy towards Industry and business was indifferent. The
first century of British rule saw the decline of nearly all indigenous industries for many
reasons– technological, economic and political. The British did not become a ruling power in
India until the second half of the 18th century till when it was as trading concern. Modern
industrial enterprises in India developed only after 1850. Its earliest manifestations came on
the wake of the construction of railways, which made it essential to have modern workshops
for repair and maintenance of the rolling stock. The development of railways ended the
isolation of the villages, made the world market available to the Indian producer, facilitated
both foreign and domestic trade, and created the necessary condition for the growth of Large -
scale industry.
The outbreak of the First World War brought an end to the policy of hostility between British
Bengal Chamber of commerce and the government and forced on the Government a more
progressive policy that included selective encouragement of some industries and protective
tariff in order to meet war demands. This led to the appointment of Indian Industrial
commission in 1916 to examine and report the possibilities of industrial development in India
and subunit recommendation for policy for industrial growth. The commission presented its
report in 1918. Its proposals were based upon the fundamental principles that in the future
Government must play an active part in the industrial development of the country. It proposed
improved departmental organization for the encouragement and control of industries. Second
suggestions were made to improve technical training and education and to improve the
conditions in factories and industrial center. Third, there were proposals for the reorganization
of the scientific staff of the industrial developments. Fourth, recommendations were made for
technical and financial aid to industries, encouragement of industrial co-operatives, and
provisions of improved transport and freight facilities.
The Second World War was major watershed in the development of Government – business
relations in India. As India became the main supply base of the allied War efforts I the Far
Eastern fronts, its industrial development received a tremendous boost from the substantial
orders for logically manufactured goods and through setting up of a large number of new
industrial units. During the two brief wars that intervened between the end of the war (1945)
and independence (1947), Government efforts were mostly directed at dealing with shortages
that developed in large numbers of items both consumer goods and essential war materials. In
almost all the industries, for example cotton, textile, cement, steel sugar and paper, production
showed a steep downward trend caused by the fall in demand, overworking of the plants during
the war, non-availably of capital requirement, shortage of many materials, general unrest in the
country and transport and distribution bottlenecks. Government efforts were mainly directed at
price and distribution controls through emergency powers in respect of a whole range of articles
like cotton, textile, woolens, and paper, coal, steel, mica, petroleum and petroleum products.
Pandit Jawaharlal Nehru laid the foundation of modern India. His vision and determination
have left a lasting impression on every facet of national endeavor since independence. The
goals and objective set out for the nation by Pandit Nehru on the eve of independence were as
follows:
1. Rapid agricultural and industrial development of the country
32
x Co-operative credit societies.
x Co-operative farming societies.
x Co-operative housing societies.
Consumers’ co-operative societies: Consumer’ cooperatives are organised by consumers to
eliminate middlemen and to establish direct relations with the manufacturers or wholesalers.
These societies are formed by consumers to ensure a steady supply of goods and services of
high quality at reasonable prices. It purchases goods either from the manufacturers or
wholesalers for sale at reasonable prices. The profit if any, is distributed among members as
dividend in the ratio of capital contributed and also bonus in proportion to the purchases made
by them.
Producers’ co-operative societies: Producers’ cooperative are formed to help the members in
procuring inputs for production of goods or services. These societies generally provide raw
material, tools and equipment and other common facilities to its members. This helps them to
concentrate their attention on production of goods. The society provides inputs to the members
and takes over their output for sale to outsiders. The basis for distribution of bonus is the goods
delivered for sale by each member.
Co-operative marketing societies: Co-operative marketing societies are voluntary
associations of small producers, who find it difficult to individually sell their products at a
profit. The main purpose of such a society is to ensure a steady and favourable market for the
output of its members. The output is pooled together and sold at the best price. The sale
proceeds are distributed in proportion to the contribution of the members to the pool. Marketing
co-operatives eliminate middlemen and ensure honest trading practices in weighing, measuring
and accounting.
Co-operative credit societies: Such societies are formed to provide financial help in the form
of loans to members. The funds of these societies consist of share capital contributed by the
members and the deposits made by them and outsiders. The funds are used in giving loans to
needy members on easy terms. Thus, the members are protected from the exploitation of
moneylenders, who charge very high rates of interest. Another important purpose of credit co-
operatives is to encourage the habit of thrift among their members.
Co-operative farming societies: In co-operative farming societies, small farmers join
together and pool their resources for cultivating their land collectively. Their objective is to
achieve economies of large scale farming and maximising agricultural output. Such societies
are particularly important in the case of countries like India, where agriculture suffers from
excessive sub-division and fragmentation of land. Co-operative farming makes it possible for
members to use modem tools and equipments, good seeds, fertilizer and irrigation facilities in
order to achieve higher production.
Co-operative housing societies: They are formed to provide residential accommodation to the
members. They undertake the purchase and development of land and/or construction of
houses/flats on the land. Some housing co-operatives provide their members with necessary
loans at low rates of interest to build houses. These societies are gaining popularity in big cities.
26
3. Large Scale Operation: The capacity of the corporate organizations to raise the funds is
comparatively high which provide capital for large scale operations. Hence opens the scope for
expansion.
4. Transferability of Shares: In a joint stock company it is easy to transfer shares to anyone.
But the same is not permitted to private limited company.
5. Raising of Funds: It is easy to raise a large amount of funds as the number of persons
contributing to the capital are more.
6. Social Benefit: It offers employment to a large number of people. It facilitates promotion of
various ancillary industries. It also donates money for education, community service.
7. Research and Development: It invests a lot of money on research and development for
improved production process, improving quality of product, designing and innovating new
products etc.
Disadvantages of Joint Stock Company
1. Formation is not easy: To act as a legal entity a company has to fulfil various legal and
procedural formalities making it a complicated process.
2. Double Taxation: This is the biggest disadvantage which the company faces. Firstly,
company needs to pay tax for the earned profits and again the shareholders are taxed for the
earned income.
3. Control by Board of Directors: After electing directors of the company which manage the
business for the company the shareholders become ignorant of their responsibilities. This may
be due to lack of interest and lack of proper and timely information.
4. Excessive Government Control: A company has to comply with provisions of several acts,
non-compliance of which can cause a company heavy penalty. This affects the smooth
functioning of a company.
5. Delay in Policy Decisions: All the legal and procedural formalities which are required to
fulfil before making policies of the company delay the policy decisions.
6. Speculation and Manipulation: As the shares of a joint stock company are easily
transferable thus the shares are purchased and sold in the stock exchanges on the value or price
of a share based on the expected dividend and the reputation of the company.
Types of Companies
We find a variety of companies in our county. The formations, liability, management and
ownership of all companies differ from each other. Companies can be classified on the basis
of their ownership and nationality. Accordingly, there three type of companies - Private
Limited, Public Limited and Government companies on the basis of ownership and two types
of companies - Indian and Foreign, on the basis of nationality.
30
2. Rapid expansion of opportunities for gainful employment
3. Progressive reduction of social and economic disparities
4. Removal of poverty and attainment of self-reliance
The emergence of India as an independent nation of August 15, 1947, was the beginning of the
new glorious era in the history of our country. Initial Government efforts were directed towards
improving the climate of industrial relations. On April 1948, the Parliament adopted an
Industrial Policy Resolution laying down the broad objectives of the government policy in the
field of industrial development and demarcating the respective shapers for public and private
sector. The government also took steps to clarify its policy toward foreign capital in a policy
statement made by the Prime Minister on April 6, 1949. Since 1950-51, India has passed
through eleven five-year plans and is now in the 12th Five-year plan. The financial and the
balance of payment crises that the nation faced from the onset of the 1990s compelled the
acceptance of deregulation, reduced role for public sector, making the public sector efficient
and surplus generating, and much reliance in general on the private sector for industrial and
infrastructure development.
Industrial Policies
Industrial Policy means rules, regulations, principles, policies and procedures laid down by
government for regulating, developing and controlling industrial undertakings in the country.
It prescribes the respective roles of the public, private, joint and co-operative sectors for the
development of industries. It also indicates the role of the large, medium and small-scale sector.
It incorporates fiscal and monetary policies, tariff policy, labor policy, and the Government
attitude towards foreign capital and the role to be played by Multinational corporations in the
development of the industrial sector. After independence, the Government of India had
formulated policies for industrial growth and development. For regulating these industrial
policies, adequate measures were also adopted by way of industrial licensing policies. These
policies have substantial regulated the business environment in the country.
Objectives of Industrial Policies
Industrial policy statements have been announced from 1948 onwards. A number of objectives
have been projected by the Government of India while making industrial policy declarations.
Some of the important objectives of the Industrial policies were as follows:
• Achieving a socialistic pattern of society
• Preventing undue concentration of economic power
• Achieving industrial development
• Achieving economic growth
• Reducing disparities in regional development
• Developing heavy and capital goods industry
• Providing opportunities for gainful employment
• Expanding the public sector for achieving socialism
33
x Increase in forest and tree cover to 25% by 2007 and 33% by 2012.
x All villages to have sustained access to potable drinking water by 2012.
x Cleaning of all major polluted rivers by 2007 and other notified stretches
by 2012.
Eleventh Plan Goals:
(2007 - 2012)
x Accelerate GDP growth from 8% to 10%. Increase agricultural GDP
growth rate to 4% per year.
x Create 70 million new work opportunities and reduce educated
unemployment to below 5%.
x Raise real wage rate of unskilled workers by 20 percent.
x Reduce dropout rates of children from elementary school from 52.2% in
2003-04 to 20% by 2011-12. Increase literacy rate for persons of age 7
years or above to 85%.
x Lower gender gap in literacy to 10 percentage point. Increase the
percentage of each cohort going to higher education from the present 10%
to 15%.
x Reduce infant mortality rate to 28 and maternal mortality ratio to 1 per
1000 live births
x Reduce Total Fertility Rate to 2.1
x Provide clean drinking water for all by 2009. Reduce malnutrition among
children between 0-3 years to half its present level. Reduce anemia among
women and girls by 50%.
x Raise the sex ratio for age group 0-6 to 935 by 2011-12 and to 950 by
2016-17
x Ensure that at least 33 percent of the direct and indirect beneficiaries of
all government schemes are women and girl children
x Ensure all-weather road connection to all habitation with population 1000
and above (500 in hilly and tribal areas) by 2009, and ensure coverage of
all significant habitation by 2015
x Connect every village by telephone by November 2007 and provide
broadband connectivity to all villages by 2012
x Increase forest and tree cover by 5 percentage points.
x Attain WHO standards of air quality in all major cities by 2011-12.
x Treat all urban waste water by 2011-12 to clean river waters.
x Increase energy efficiency by 20 percentage points by 2016-17.
37
Actual x Shifted basic emphasis from agriculture to industry far too soon.
Growth: 4.27%
x During this plan, prices increased by 30%, against a decline of 13%
during the First Plan
Third Plan x At its conception, it was felt that Indian economy has entered a take-off
(1961 - 66) stage. Therefore, its aim was to make India a 'self-reliant' and 'self-
|Target generating' economy.
Growth: 5.6%
x Based on the experience of first two plans, agriculture was given top
Actual priority to support the exports and industry.
Growth: 2.84%
x Complete failure in reaching the targets due to unforeseen events -
Chinese aggression (1962), Indo-Pak war (1965), severe drought 1965-66
Three Annual x Prevailing crisis in agriculture and serious food shortage necessitated the
Plans (1966- emphasis on agriculture during the Annual Plans
69) Plan
holiday for x During these plans a whole new agricultural strategy was implemented. It
3years. involving wide-spread distribution of high-yielding varieties of seeds,
extensive use of fertilizers, exploitation of irrigation potential and soil
conservation.
x During the Annual Plans, the economy absorbed the shocks generated
during the Third Plan
x It paved the path for the planned growth ahead.
Fourth Plan x Main emphasis was on growth rate of agriculture to enable other sectors
(1969 - 74) to move forward
Target Growth:
5.7% x First two years of the plan saw record production. The last three years did
not measure up due to poor monsoon.
Actual
Growth: 3.30% x Influx of Bangladeshi refugees before and after 1971 Indo-Pak war was
an important issue
Fifth Plan x The fifth plan was prepared and launched by D.D. Dhar.
(1974-79)
Target Growth: x It proposed to achieve two main objectives: 'removal of poverty' (Garibi
4.4% Hatao) and 'attainment of self-reliance'
Actual x Promotion of high rate of growth, better distribution of income and
Growth: 3.8 significant growth in the domestic rate of savings were seen as key
instruments
x The plan was terminated in 1978 (instead of 1979) when Janta Party Govt.
rose to power.
There were 2 Sixth Plans. Janta Govt. put forward a plan for 1978-1983.
Rolling Plan
However, the government lasted for only 2 years. Congress Govt. returned to
(1978 - 80)
power in 1980 and launched a different plan.
35
acquisition of expertise in information technology has led to the generation of thousands of
new jobs, which in turn increased domestic consumption and naturally, more foreign direct
investments happened to meet the demands.
Presently, the services sector employs 23% of the Indian workforce and this process of
development started back in the 1980s. In the 60s, the sector employed only 4.5% of the
working population. According to the Central Statistical Organization, the services sector
accounted for 63% of Indian GDP in 2008 and the figure continues to grow.
Growth of Agriculture Sector
Since 1950s, the progress in agriculture has been somewhat steady. The sector grew at about 1
percent per annum in the first half of the 20th century. During the post-Independence era, the
growth rate nudged about 2.6 percent per annum. Expansion of farming area and introduction
of high-yielding varieties of crops were the major factors of growth in agricultural production.
The sector could manage to end dependency on imported food grains. It has progressed both
in terms of yield and structural changes.
Consistent investment in research, land reforms, expansion of scope for credit facilities, and
improvement in rural infrastructure were some other determining factors that brought about an
agricultural revolution in the country. The country has also grown strong in the agri-biotech
sector. The Rabo bank report reveals that the agri-biotech sector has been growing at 30 percent
since the last few years. The country is also likely to become a major producer of genetically
modified/engineered crops.
Infrastructure Development
The Indian road network has become one of the largest in the world with the total road length
increasing from 0.399 million km in 1951 to 4.24 million km as of July 2014. Moreover, the
total length of the country’s national highways has increased from 24,000 km (1947-69) to
92,851 km (2014). Governmental efforts have led to the expansion of the network of State
highways and major district roads, which in turn has directly contributed to industrial growth.
As India needs power to drive its growth engine, it has triggered a noteworthy improvement in
the availability of energy by adopting a multi-pronged approach. After almost seven decades
of Independence, India has emerged as the third largest producer of electricity in Asia. It has
increased its electricity generation capacity from 1,362 MW in 1947 to 1,13,506 MW as of
2004. Overall, power generation in India has increased from 301 billion units (BUs) during
1992- 93 to 558.1 BUs in 2003- 04. When it comes to rural electrification, the Indian
government has managed to bring lights to 5,93,732 (2013 figures) villages as compared to
3061 in 1950.
Progress in Education Sector
Pulling itself out from widespread illiteracy, India has managed to bring its education system
at par with the global standard. The number of schools witnessed a dramatic increase during
the post-independence era. The Parliament made elementary education a fundamental right for
children in the age group of 6-14 years by passing the 86th amendment to the Constitution in
2002. At independence, India’s literacy rate was a paltry 12.2 % which increased to 74.04% in
2011.
The Government launched the Sarva Siksha Abhiyan in 2001 to ensure education for the
children from 6 to 14 years. Prior to that, it had launched an effective initiative – Sponsored
District Education Programme, which increased the number of schools across the country. In a
39
 Sixth Plan
(1980 - 85) Focus - Increase in national income, modernization of technology, ensuring
Target Growth: continuous decrease in poverty and unemployment, population control through
5.2% Actual family planning, etc.
Growth: 5.66%
Seventh Plan x Focus - rapid growth in food-grains production, increased employment
(1985 - 90) opportunities and productivity within the framework of basic tenants of
Target Growth: planning.
5.0% Actual
Growth: 6.01% x The plan was very successful, the economy recorded 6% growth rate
against the targeted 5%.
Eighth Plan x The eighth plan was postponed by two years because of political
(1992 - 97) uncertainty at the Centre
x Worsening Balance of Payment position and inflation during 1990-91
were the key issues during the launch of the plan.
x The plan undertook drastic policy measures to combat the bad economic
situation and to undertake an annual average growth of 5.6%
x Some of the main economic outcomes during eighth plan period were
rapid economic growth, high growth of agriculture and allied sector, and
manufacturing sector, growth in exports and imports, improvement in
trade and current account deficit.
Ninth Plan
(1997- 2002)
It was developed in the context of four important dimensions: Quality of life,
Target Growth:
generation of productive employment, regional balance and self-reliance.
6.5% Actual
Growth: 5.35%
Tenth Plan Goals
(2002 - 2007)
x To achieve 8% GDP growth rate
x Reduction of poverty ratio by 5 percentage points by 2007.
x Providing gainful high quality employment to the addition to the labour
force over the tenth plan period.
x Universal access to primary education by 2007.
x Reduction in gender gaps in literacy and wage rates by at least 50% by
2007.
x Reduction in decadal rate of population growth between 2001 and 2011
to 16.2%.
x Increase in literacy rate to 72% within the plan period and to 80% by
2012.
x Reduction of Infant Mortality Rate (IMR) to 45 per 1000 live births by
2007 and to 28 by 2012.
36
bid to attract children to schools, especially in the rural areas, the government also started
implementing the mid-day meals programme in 1995.
Achievements in the Field of Healthcare
A decrease in death rates is considered one of the major achievements that came India’s way
in this sector. While life expectancy was around 37 years in 1951, it almost doubled to 65 years
by 2011. Infant mortality has also seen a marked decline with death rate coming down to half
of what it was during the 50s. Similar improvement was noticed in maternal mortality rate also.
After a long-drawn struggle, India has finally been declared a polio-free country. Malnutrition
in children under five years came down to 44% in 2006 from 67% in 1979. Government’s
efforts yielded result as the number of tuberculosis cases also got reduced to 185 per lakh
people in 2009. The cases of HIV-infected people are also witnessing a declining trend. Besides
increased public health spending (about 6% of the GDP), the government has launched a series
of ambitious initiatives including ‘Healthcare for all by 2020′ and distribution of free medicines
to the people falling under lowest-income group.
Scientific Achievements
Independent India has taken confident strides in its road to scientific development. Its prowess
is being manifested in a gradual scaling up of ambitious projects. India takes pride in its space
programmes, which began with the launch of its first satellite Aryabhatta in 1975. Since then,
India has emerged as a space power that has successfully launched foreign satellites. Its first
mission to Mars was launched in November 2013 which successfully reached the planet’s orbit
on 24 September 2014.
India is also aggressively pursuing both nuclear and missile programmes. That has
simultaneously augmented the country’s defence strength as well. BrahMos inducted into the
defence system is the world’s fastest cruise missile that has been jointly developed by India
and Russia. After more than six decades of independence, India has now come closer to being
an independent force to reckon with in the field of nuclear and missile technology.
Role of agriculture and industry in economic development with reference to Indian
economy
Agriculture is not only important but it also provides a base for development. In India, the
agricultural sector occupies a vital position in the overall economy of the country as would be
clear from the following:
i. Share of Agriculture in National Income: Agriculture has got a prime role in Indian
economy. Though the share of agriculture in national income has come down, still it has a
substantial share in GDP.
ii. Important Contribution to Employment: Agriculture sector, at present, provides
livelihood to 65 to 70 per cent of the total population. The sector provides employment to 58.4
per cent of country’s workforce and is the single largest private sector occupation.
iii. Important Source of Industrial Development: Various important industries in India find
their raw material from agriculture sector -cotton and jute textile industries, sugar, vanaspati,
etc. are directly dependent on agriculture. Handlooms, spinning oil milling, rice thrashing, etc.
are various small scale and cottage industries, which are dependent on agriculture sector for
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• Achieving a self-sustained economy
• Alleviating poverty
• Protecting and developing a healthy small sector
• Building up large and growing co-operative sector
• Updating technology and modernization of industry
• Liberalization and Globalization of economy
Industrial Policy Resolutions
Following are the important Industrial Policy Resolutions, post-independence:
• Industrial Policy Resolution, 1948
• Industrial Policy Resolution, 1956
• New Industrial Policy Resolution, 1991
Indian Planning process
The objective of India’s development strategy has been to establish a socialistic pattern of
society through economic growth with self-reliance, social justice and alleviation of poverty.
These objectives were to be achieved within a democratic political framework using the
mechanism of a mixed economy where both public and private sectors co-exist. India initiated
planning for national economic development with the establishment of the Planning
Commission.
For the smooth functioning of any economy, planning plays an important role. The Planning
Commission has been entrusted with the responsibility of the creation, development and
execution of India's five year plans. India's five year plans are also supervised by the Planning
commission.
Currently, the 12th Five Year Plan, is underway.
Details of each Five Year Plan are as follows:
Plan Notes
First Plan x It was based on Harrod-Domar Model.
(1951 - 56)
x Community Development Program launched in 1952
x Focus on agriculture, price stability, power and transport
x It was a successful plan primarily because of good harvests in the last two
years of the plan
Second Plan x Also called Mahalanobis Plan named after the well-known economist
(1956 - 61)
x Focus - rapid industrialization
Target Growth:
4.5% x Advocated huge imports through foreign loans.
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12th five year plan (2012-2017):
The Planning Commission of India posted the draft Document of the 12th Five year Plan on its
website in the first week of December 2012 for feedback from the public before it is adopted
by the National Development Council (NDC) on 28 December and declared the Five Year Plan
for the country from 2012 to 2017. The stated vision of the Plan Document is “of India moving
forward in a way that would ensure a broad-based improvement in living standards of all
sections of the people through a growth process which is faster than in the past, more inclusive
and also more environmentally sustainable”. This mantra of “faster, sustainable and more
inclusive growth”’ is indeed ideal and laudable
The aim of the 12th five year plan is to renew Indian economy and use the funds from
government in improving the facilities of education, sanitation and health. This plan has seen
a three-fold increase in the budget constraints when compared to that of the 11th five-year plan.
The plan would infuse a huge fund of 47.7 lakh crore rupees and this will help to accomplish
the economic growth to an average level of 8.2 percent.12th five-year plan is guided by the
policy guidelines and principles to revive the following Indian economy, which registered a
growth rate of meagre 5.5 percent in the first quarter of the financial year 2012-13.The plan
aims towards the betterment of the infrastructural projects of the nation avoiding all types of
bottlenecks. The document presented by the planning commission is aimed to attract private
investments of up to US$1 trillion in the infrastructural growth in the 12th five-year plan, which
will also ensure a reduction in subsidy burden of the government to 1.5 percent from 2 percent
of the GDP (gross domestic product) & the UID (Unique Identification Number) will act as a
platform for cash transfer of the subsidies in the plan. The plan aims towards achieving a
growth of 4 percent in agriculture and to reduce poverty by 10percentage points, by 2017.
Development in India after Independence
While some have a high opinion of India’s growth story since its independence, some others
think the country’s performance in the six decades has been abysmal. It’s arguably true that the
Five-Year Plans did target specific sectors in order to quicken the pace of development, yet the
outcome hasn’t been on expected lines. And, the country is taking its own sweet time to catch
up with the developed world. All efforts are frustrated by lopsided strategies and inept
implementation of policies.
The Two Phases of Economy
An independent India was bequeathed a shattered economy, widespread illiteracy and shocking
poverty. Contemporary economists divide the history of India’s economic growth into two
phases – first 45 years after independence and the two decades of free market economy. The
years preceding the economic liberalisation were mainly marked by instances wherein
economic development got stagnated due to a lack of meaningful policies.
The economic reforms came to India’s rescue with the launching of a policy of liberalisation
and privatisation. A flexible industrial licensing policy and a relaxed FDI policy started getting
positive responses from international investors. Among the major factors that drove India’s
economic growth following the economic reforms of 1991 were increased FDI, adoption of
information technology and an increased domestic consumption.
Service Sector Growth
A major development in the nation’s services sector has been the tele-services and information
technology. A trend that started some two decades back is now well in its prime. Several
multinational firms continue to outsource their tele services and IT services to India. The
38
their raw material. This highlights the importance of agriculture in industrial development of
the nation.
iv. Importance in International Trade: India’s foreign trade is deeply associated with
agriculture sector. Agriculture accounts for about 14.7 per cent of the total export earnings.
Besides, goods made with the raw material of agriculture sector also contribute about 20 per
cent in Indian exports. In other words, agriculture and its related goods contribute about 38 per
cent in total exports of country.
In short, agriculture occupies a central place in the Indian economy. Its performance sets the
pace of growth in the economy as a whole. It should, however, be noted that Indian agriculture
is still in the state of backwardness, the per capita productivity in agriculture is less than in
industry.
Role and importance of industries in Indian economy
Economic development of any nation totally depends on industries. Industries play an
important role in the Indian Economy. Without industries, economic development is not
possible. A growing industrial sector is crucial to greater economic development and takes in
a number of areas as a country develops. Ensuring steady industrial growth helps to compliment
and sustain continued economic development. A well-developed industrial sector, covering
various different areas is vital to the economic development of a country. With a variety of
different industrial sectors that feed off each other, a well-balanced industrial sector is at the
centre of economic development. With a 2. To make the import-export policy of the country more liberal and so that the export of
strong industrial base, economic planning becomes less risky, being able to plan ahead also
assists industrial growth with profits re-invested into infrastructure development which in turn
helps to boost and attract industry. In a backward and developing economy like India, industries
are indispensable. Development of industries is not only indispensable for India, but there is
also good scope for the development of industries in India. India has many favourable factors
for the development of industries.
Role of Industrial Development in Economic Growth
1. Modernisation of Industry: Industrial development is necessary for modernisation of
agriculture. In India, agriculture is traditional and backward. The cost of production is high and
productivity is low. We need tractors, threshers, pump sets and harvesters to modernise
agriculture. To increase productivity, we need chemical fertilizers, pesticides and weedicides
etc. These are all industrial products. Without industrial development, these goods cannot be
produced. Agricultural products like jute, cotton, sugarcane etc. are raw materials. To prepare
finished products like flex, textiles and sugar etc. we need industrialisation. So industrial
development is necessary for modernisation of agriculture.
2. Development of Science and Technology: Industrial development encourages the
development of science and technology. The industrial enterprises conduct research and
develop new products. Due to industrialisation, we have made progress in atomic science,
satellite communication and missiles etc.
3. Capital Formation: Acute deficiency of capital is the main problem of Indian economy. In
agricultural sector, the surplus is small. Its mobilisation is also very difficult. In large scale
industries, the surplus is very high. By using external and internal economies, industry can get
higher profit. These profits can be reinvested for expansion and development. So
industrialisation helps in capital formation.
41
Stages of Economic Development
Rostow’s Five Stages of Growth
1. Traditional Society:
This initial stage of traditional society signifies a primitive society having no access to modern
science and technology. In other words, it is a society based on primitive technology and
primitive attitude towards the physical World. Thus, Rostow defines a traditional society “as
one whose structure is developed within the limited production function based on pre-
Newtonian science and technology and as pre-Newtonian attitudes towards the physical world”
However, Rostow does not view this traditional society as being completely static. In this stage
of a society output could be increasing through the expansion of land area under cultivation or
through the discovery and spread of a new crop. But the critical fact about this type of society
is that there is limit to attainable output per head. This limit arises due to the absence of access
to modern science and technology. This type of a society allocates a large proportion of its
resources to agriculture and is characterised by a hierarchical social structure in which there is
little possibility for vertical mobility.
The value system that prevails in such a society is what Rostow calls a long-run fatalism.
People of these societies think that not much economic progress is possible for them and for
their future generations.
2. Pre-Conditions or the Preparatory Stage:
The covers a long period of a century or more during which the preconditions for take-off are
established. These conditions mainly comprise fundamental changes in the social, political and
economic fields; for example:
(a) A change in society’s attitudes towards science, risk-taking and profit-earning;
(b) The adaptability of the labour force;
45
At the same time the foreign exchange stock was also decreasing. In 1990 and 1991 the
government of India had to take huge amount of loan from the IMF as compensatory financial
facility. Even by mortgaging 46 tons of gold it had taken short term foreign loan from the Bank
of England.
At the same time, India was also suffering from inflation, the rate of which was 12% by 1991.
The reasons of that inflation were the increase in the procurement price of the agricultural
products for distribution, the increase in the amount of monetized deficit in the budget, increase
of import cost and decrease in the rate of currency exchange and Administered price like. Thus
she was facing trade deficit as well as Fiscal Deficit.
To get relief from such a grave problem the government of India had only two ways before it
1. To take foreign debt and to create favourable conditions within the country for increasing
the flow of foreign exchange and also to increase the volume of export.
2. The other was to establish fiscal discipline within the country and to make structural
adjustment for the purpose.
Hence the government of India had to introduce a package of reforms which included:
1. To liberalize the industrial policy of the government and to invite foreign investment by
privatization of industries and abolishing the license system as a part of that liberalization.
Indian goods may become more easy and the necessary raw materials and instruments for
both industrial development and production of exportable commodities may be imported
and also to facilitate free trade by reducing the import duty.
3. To decrease the value of money in terms of dollar
4. To take huge amount of foreign debt from the IMF and the world Bank for rejuvenating
the economic condition of the country and to introduce the structural adjustment in the
economic condition of the country as a pre-condition of that debt,
5. To reform the banking system and the tax structure of the country and
6. To establish market economy by withdrawing and restricting government interference on
investment.
The process of economic reforms was started by the government of India in 1991 for taking
the country out of economic difficulty and speeding up the development of the country. The
centre of economic reforms has been liberalization, privatization and globalization these three
terms are explained as follows:
(A) Liberalization:
Liberalization means to unshackle the economy from bureaucratic cobweb to make it more
competitive. Following are its chief features:
(i) To do away with the necessity of having a license for most of the industries
(ii) Freedom in determining the scale of business activities
(iii) Removing restrictions for the movement of goods and services from one place to another
(iv) Freedom to fix the prices of goods and services
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It is worth noting that in the opinion of Rostow, the rise of new elite (i.e. new entrepreneurial
class) and establishment of a nation state are crucial for economic development.
4. Drive to Maturity: Period of Self-sustained Growth:
This stage of economic growth occurs when the economy becomes mature and is capable of
generating self-sustained growth. The rates of saving and investment are of such a magnitude
that economic development becomes automatic. Overall capital per head increases as the
economy matures. The structure of the economy changes increasingly.
The initial key industries which sparked the take-off decelerate as diminishing returns set in.
But the average rate of growth is maintained by a succession of new rapidly-growing sectors
with a new set of leading sectors. The proportion of the population engaged in agriculture and
other rural pursuit’s declines, and the structure of the country’s foreign trade undergoes a
radical change.
It is with both the problems and the cyclical movements of national income in such mature
growing economies in this fourth stage that the bulk of modern theoretical economics is
concerned. The students of contemporary developing countries and also of economic history
are more likely to be concerned with the economics of the previous two stages, that is, the
economics of the preparatory and the ‘take-off’ stages. If we are to have a useful and adequate
theory of economic growth, it must obviously be comprehensive enough to embrace these two
stages as well, especially the economics of the “take-off into self-sustaining growth”.
5. Stage of Mass Consumption:
In this stage of development per capita income of country rises to such a high level that
consumption basket of the people increases beyond food, clothing and shelters to articles of
comforts and luxuries on a mass scale. Further, with progressive industrialisation and
urbanisation of the economy values of people change in favour of more consumption of
luxuries and high styles of living. New types of industries producing durable consumer goods
come into existence which satisfies the wants for more consumption. These new industries
producing durable consumer goods become the new leading sectors of economic growth.
Features of under development with reference to India
An underdeveloped country is a country characterised by poverty, with beggars in the cities,
and villagers eking out a bare subsistence in the rural areas. It is a country lacking in factories
of its own. It usually has insufficient roads and rail-roads, insufficient government services and
poor communication. It has few hospitals and few institutions of higher learning. Most of its
people cannot read and write. In spite of the generally prevailing poverty of the people, it may
have isolated islands of wealth with a few persons living in luxury. Its banking system is poor,
small loans have to be obtained through money-lenders who are little better than extortionists.
The exports of an underdeveloped country usually consist of raw materials or ores or fruits or
some staple products. Often the extraction or cultivation of these raw material exports is in the
hands of foreign companies.
Whatever be the criteria, India is at present an underdeveloped economy.The following
characteristics of an underdeveloped economy are found in the Indian economy:
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(v) Reduction in the rate of taxes
(vi) Freedom from unnecessary control over economy
(vii) Simplifying import-export procedure
(viii) Simplifying the process of attracting foreign capital and technology.
(B) Privatization:
In brief, privatization means such an economic process through which some public sector
undertaking is brought either partially or completely under private ownership. Broadly
speaking, establishing a new enterprise in private sector instead of public sector is also
privatization. Not only this, depriving public sector of the job of production which was earlier
reserved for it or transferring its production, without depriving it, to the private sector also
amounts to privatization. Its chief features are given below:
(i) Reducing the role of public sector and increasing the role of private sector
(ii) Reducing fiscal burden of the government
(iii) Reducing the size of the government machinery
(iv) Speeding up economic development
(v) Improving management of enterprises
(vi) Increase in government treasury
(vii)Increasing competition by opening industries reserved for the public sector to the private
sector.
(C) Globalization:
Globalization means integrating the economy with the rest of the world. Following are its chief
features:
(i) Free flow of goods and services in all the countries
(ii) Free flow of capital in all the countries
(iii) Free flow of information and technology in all the countries
(iv) Free movement of people in all the countries
(v) The same conflict-solving technique in all the countries.
44
1. Low per Capita Income: An underdeveloped country is a poor country. The per capita
income of the people of India is very low in comparison with that of the USA, the UK, Canada,
Australia and Japan. The low per capita income is reflected in the low standards of living of
the people.
2. Inequitable Distribution of Wealth and Income: Like most underdeveloped countries the
distribution of income and wealth in India is inequitable. The gap between the haves and the
have-nots over the years has actually widened and there has been concentration of wealth and
economic power in the hands of a few to the detriment of the common people. This is not
surprising because private ownership of the means of production inevitably leads to
concentration of wealth in a few hands. Income inequalities result from the concentration of
wealth and capital. The problem of mass poverty is a corollary to income inequalities.
3. Predominance of Agriculture: In an underdeveloped country two-thirds of the people live
in rural areas and their main occupation is agriculture. A developed economy is generally a
highly industrialised country where agriculture occupies a comparatively less important place.
4. Deficiency of Capital: Another criterion of underdevelopment is the low ratio of capital
availability per head of population. An underdeveloped economy is an economy in which the
available stock of goods is not sufficient to employ the total available labour force on the basis
of modern technique of production. Not only the existing stock of capital is small but the
current rate of capital formation is also very low. Because of shortage of capital, there is a
tendency to invest the available capital in farming and labour-intensive consumer goods
industries rather than in the heavier capital-intensive capital goods industries.
There are a number of reasons for capital deficiency: (i) shortage of savings, (ii) the tendency
of the meagre savings to go into conspicuous consumption and (iii) speculative investment
rather than productive investment.
5. High Rate of Population Growth: Like all other underdeveloped countries, the population
of India has been increasing at an alarmingly high rate. India’s population was 85 crores in
1991 as against 68 crores in 1980 and the country has the second largest population in the world
next to China.
6. Unemployment and Underemployment: Widespread unemployment and
underemployment is an important feature of the Indian economy. Owing to huge population,
the supply of labour far exceeds the demand for labour. It is very difficult to provide gainful
employment to all. The main reason is that there is a shortage of capital. India does not have
sufficient amount of capital to expand industries so that the entire labour force is absorbed.
The nature of unemployment in India is different from what it is in the developed countries. In
a developed economy, unemployment is of a cyclical nature and occurs due to lack of effective
demand. In contrast, unemployment in India is structural and has arisen due to lack of capital.
There are two reasons for urban unemployment. First, the failure of the industrial sector to
expand at a fast enough rates has resulted in industrial unemployment. Secondly, expansion of
education has created demand for white collar jobs which the country’s urban economy has
failed to provide.
7. A Dualistic Economy: All the underdeveloped countries including India have a dualistic
economy. One is the market economy and the other is the subsistence economy.
48
4. Industrialisation and Urbanisation: Urbanisation succeeds industrialisation.
Industrialisation in a particular region brings growth of transport and communication. Schools,
colleges, technical institutions, banking and health facilities are established near industrial
base.
5. Self-reliance in Defence Production: To achieve self-reliance in defence production,
industrialisation is necessary. During war and emergency dependence on foreign countries for
war weapons may prove fatal. Self-reliance in capital goods and industrial infra-structure is
also necessary.
6. Importance in International Trade: Industrialisation plays an important role in the
promotion of trade. The advanced nations gain in trade than countries who are industrially
backward. The underdeveloped countries export primary products and import industrial
products. Agricultural products command lower prices and their demand is generally elastic.
While industrial products command higher values & their demand is inelastic. This causes trade
gap. To meet the deficit in balance of payments we have to produce import substitute products
or go for export promotion through industrial development.
7. Use of Natural Resources: It is a common saying that India is a rich country inhabited by
the poor. It implies that India is rich in natural resources but due to lack of capital and
technology, these resources have not been tapped. Resources should be properly utilized to
transform them into finished industrial products. The British people took India’s cheap raw-
materials for producing industrial goods in their country. India was used as a market for their
industrial products. So India fought with poverty and England gained during industrial
revolution. Hence industrialisation plays important role for proper utilisation of resources.
8. Alleviation of Poverty and Unemployment: Poverty and unemployment can be eradicated
quickly through rapid industrialisation. It has occurred in industrially advanced countries like
Japan. The slow growth of industrial sector is responsible for widespread poverty and mass
unemployment. So with fast growth of industrial sector, surplus labour from villages can be
put into use in industry.
9. Main Sector of Economic Development: Industry is viewed as leading sector to economic
development. We can have economies of scale by applying advanced technology and division
of labour and scientific management. So production and employment will increase rapidly.
This will bring economic growth and capital formation.
10. Fast Growth of National and Per Capita Income: Industrial development helps in the
rapid growth of national and per capita income. The history of economic development of
advanced countries shows that there is a close relation between the level of industrial
development and the level of national and per capita income.
11. Sign of Higher Standard of Living and Social Change: A country cannot produce goods
and services of high quality in order to attain decent living standard without the progress of
industrial sector.
Economic Policy Reforms Since 1991
The Indian Government has introduced many Economic Reforms in India since 1991. In 1990-
91 India had to face grave economic problem. India was facing serious deficiency in her foreign
trade balance and it was increasing. Since 1987-88 till 1990-91 it was increasing in such a rapid
scale that by the end of 1990-91 the amount of this deficit balance became 10,644 crores of
rupees.
42
(c) Political sovereignty;
(d) Development of a centralised tax system and financial institutions; and
(e) The construction of certain economic and social infrastructure like railways, ports, power
generation and educational institutions. India did some of these things in the First Five Year
plan period (1951-56).
It is evident from above that in this second stage of growth foundations for economic transfor-
mation are laid. The people start using modern science and technology for increasing
productivity in both agriculture and industry.
Further, there is a change in the attitude of the people who start viewing the world where there
are possibilities of future growth. A new class of entrepreneurs emerges in the society who
mobilise savings and undertake investment in new enterprises and bear risks and uncertainty.
In the sphere of political organisation, it is during this stage that an effective centralised nation
state starts emerging.
Thus in the stage of precondition for take-off Rostow views agriculture as performing three
roles, first, agriculture must produce sufficient food-grains to meet the demand of growing
population and of the workers who get employment in agriculture.
Secondly, increase in agricultural incomes would lead to the demand for industrial products
and stimulate industrial investment.
Thirdly, expanding agriculture must provide much of the savings needed for the expansion of
the industrial sector.
3. The “Take-off” Stage:
This is the crucial stage which covers a relatively brief period of two to three decades in which
the economy transforms itself in such a way that economic growth subsequently takes place
more or less automatically. “The take-off” is defined as “the interval during which the rate of
investment increases in such a way that real output per capita rises and this initial increase
carries with it radical changes in the techniques of production and the disposition of income
flows which perpetuate the new scale of investment and perpetuate thereby the rising trend in
per capita output.”
Thus, the term “take-off ” implies three things : first the proportion of investment to national
income must rise from 5% to 10% and more so as to outstrip the likely population growth;
secondly, the period must be relatively short so that it should show the characteristics of an
economic revolution; and thirdly, it must culminate in self-sustaining and self-generating
economic growth.
Thus, during the take-off stage, the desire to achieve economic growth to raise the living
standards dominates the society. Revolutionary changes occur in both agriculture and industry
and productivity levels sharply increase. There is greater urbanisation and urban labour force
increases. In a relatively short period of a decade or two, both the basic structure of the
economy and social and political structure is changed So that a self-sustaining growth rate can
be maintained.
46
One is in the urban areas and the other is in the rural areas. One is developed and the other is
undeveloped. The modern or the developed part contains mainly the large scale industry, mines
and plantations. It is well organised and highly monetised. It uses the modern techniques of
production. Workers and employers in this sector are well organised. Monetary and fiscal
measures of regulation are quite effective. This advanced sector of the economy accounts for a
small part of the whole economy.
The primitive part mainly comprises agriculture and is confined to rural areas. This is very
backward and money does not play an important part in this sector. There is a high degree of
self-sufficiency and people do very little buying and selling as most of the transactions are of
a barter type.
A large part of the credit is supplied by the traditional money-lenders. Monetary and fiscal
measures of regulation are not very effective. Indian peasant is born in debt, lives in debt and
dies in debt. Income of the people of this inorganised sector is very low. Thus, the Indian
economy is characterised by economic dualism.
8. Technical Backwardness: The state of technology in the underdeveloped countries is
backward. On account of the absence of technological development, India has continued to use
old, outdated and primitive methods of production which were discarded by the developed
countries long ago.
Deficiency of capital hinders the process of scrapping the old techniques and equipment and
its replacement with modern techniques, etc. Illiteracy and absence of skilled labour are the
other major hurdles in the spread of techniques in the backward economy. However, it is
gratifying to note that the level of technology is rapidly increasing in the country and India has
the largest number of technically qualified personnel in the third world countries.
9. Social Peculiarities: High illiteracy rate, male dominated society, joint family system,
fatalism, lack of entrepreneurship, casteism, communalism, widespread child labour, etc. are
some characteristics of Indian society which distinguish it from developed societies.
International Trade
International trade means trade between the two or more countries. International trade involves
different currencies of different countries and is regulated by laws, rules and regulations of the
concerned countries. Thus, International trade is more complex.
All countries need goods and services to satisfy wants of their people. Production of goods and
services requires resources. Every country has only limited resources. No country can produce
all the goods and services that it requires. It has to buy from other countries what it cannot
produce or can produce less than its requirements. Similarly, it sells to other countries the goods
which it has in surplus quantities. India too, buys from and sells to other countries various types
of goods and services.
International or Foreign trade is recognized as the most significant determinants of economic
development of a country, all over the world. The foreign trade of a country consists of inward
(import) and outward (export) movement of goods and services, which results into. Outflow
and inflow of foreign exchange. Thus it is also called EXIM Trade.
49
“The fact of free trade establishes an overwhelming presumption that the commodities obtained
from abroad in exchange for export are so obtained at lower cost than which the domestic
production of their equivalents would entail. If this were not the case, they would not be
imported, even under free trade. It has been maintained that the gain from free international
trade would be the largest due to international specification based on comparative advantage.
Free trade leads to the most efficient conduct of economic affairs.
2. More factor earnings: Under free trade, factors of production will also be able to earn more,
as they will be employed for better use. Hence, wages, interest and rent will be higher under
free trade than otherwise.
3. Cheaper imports: Free trade procures import at cheap rates. It seems to be an attractive
argument in favour of trade at least from the customer’s point of view. However, it ignores the
question of employment and the interests of producers in the importing country. Here it has
been pointed out that under free trade, when consumers gain through lower prices producers
also gain as the factors of production are directed to more gainful and specialized production
which gives better earnings.
4. Enlarged market: Free trade widens the size of the market as a result of which greater
specialization and a more complex division of labour become possible. This brings about
optimum production with costs reduced everywhere, benefiting the world as a whole.
5. Competition:
Free trade policy encourages competition from abroad which induces domestic producers to
become more alert and improve their efficiency.
6. Restricted exploitation: Free trade prevents growth of domestic monopolies and
consumers’ exploitation due to competition from abroad.
7. Greater welfare: Free trade permits large varieties of consumption goods and improves
consumer’s welfare.
Disadvantages of Free Trade:
1. Free trade policy runs smoothly if all the countries follow the same. If some countries do not
adopt it, the system cannot work gainfully.
2. Free trade may prove advantageous to developed and technologically advanced nations, but
less developed countries are certainly at a disadvantage on account of unfavorable terms of
trade.
3. Competition induced under free trade is unfair and unhealthy. Backward countries cannot
compete with advanced countries.
4. Gains of trade are not equally distributed under free trade due to unequal state of
development of different countries.
5. A country with unfavorable balance of payments finds it difficult to overcome this situation
under free trade policy.
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(iv) Advantages of large-scale production: Due to international trade, goods are produced
not only for home consumption but for export to other countries also. Nations of the world can
dispose of goods which they have in surplus in the international markets. This leads to
production at large scale and the advantages of large scale production can be obtained by all
the countries of the world.
(v) Stability in prices: International trade irons out wild fluctuations in prices. It equalizes the
prices of goods throughout the world (ignoring cost of transportation, etc.)
(vi)Exchange of technical know-how and establishment of new industries:
Underdeveloped countries can establish and develop new industries with the machinery,
equipment and technical know-how imported from developed countries. This helps in the
development of these countries and the economy of the world at large.
(vii) Increase in efficiency: Due to international competition, the producers in a country
attempt to produce better quality goods and at the minimum possible cost. This increases the
efficiency and benefits to the consumers all over the world.
(viii) Development of the means of transport and communication: International trade
requires the best means of transport and communication. For the advantages of international
trade, development in the means of transport and communication is also made possible.
(ix) International co-operation and understanding: The people of different countries come
in contact with each other. Commercial intercourse amongst nations of the world encourages
exchange of ideas and culture. It creates co-operation, understanding, and cordial relations
amongst various nations.
(x) Ability to face natural calamities: Natural calamities such as drought, floods, famine,
earthquake etc., affect the production of a country adversely. Deficiency in the supply of goods
at the time of such natural calamities can be met by imports from other countries.
(xi) Other advantages: International trade helps in many other ways such as benefits to
consumers, international peace and better standard of living.
Disadvantages of International Trade:
(i) Impediment in the Development of Home Industries: International trade has an adverse
effect on the development of home industries. It poses a threat to the survival of infant
industries at home. Due to foreign competition and unrestricted imports, the upcoming
industries in the country may collapse.
(ii) Economic Dependence: The underdeveloped countries have to depend upon the developed
ones for their economic development. Such reliance often leads to economic exploitation. For
instance, most of the underdeveloped countries in Africa and Asia have been exploited by
European countries.
(iii) Political Dependence: International trade often encourages subjugation and slavery. It
impairs economic independence which endangers political dependence. For example, the
Britishers came to India as traders and ultimately ruled over India for a very long time.
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2. On account of economic interdependence in implementing free trade policy, many
governments experienced political handicaps, especially during war times. Hence, for
maintaining political independence, it was thought desirable to seek economic independence
with the abandonment of free trade.
3. Countries cannot allow free import of injurious and harmful products; hence, trade
restrictions become necessary.
4. Free trade led to cut-throat competition in the world market, so that, exporters resorted to
dumping, which no government can allow beyond a limit; thus, restrictions became inevitable.
5. Free entry of goods produced by powerful combines inflicts a permanent injury on the
economic interests of a country. Hence, restrictions on such items were thought inevitable.
6. Backward countries have to protect their infant industries and hence, cannot adopt the policy
of free trade.
Thus, though, in theory free trade looked better, in practice protection got the upper
hand.
Balance of Payment
Balance of Payments (BOP) is the accounting records of the monetary transactions between a
country and the other countries of the world over a fixed period of time.
These monetary transactions include inflow and outflow of financial capital and the payment
made by the country for the export and import of goods and services.
The BOP is the summarized record of the international transactions conducted by the public as
well as private organizations of the domestic country with the foreign countries. It helps in
estimating the trend of cash flow indicating how much capital has flown out of the country and
how much capital has entered in the country.
The BOP is calculated on a quarterly and yearly basis in a single currency, generally in
domestic currency of the related country. It has a debit and a credit side, where debit side shows
the assets or inflow of capital and credit side shows the liabilities or outflow of capital.
The sources of capital, such as export of goods and services, are mentioned on the credit side.
However, the uses of capital, such as import of goods and services and investment in foreign
securities, are mentioned on the debit side of the BOP.
Theoretically, the debit side of the BOP should always match with its credit side. In other
words, the summation of all the assets should be equal to the summation of all the liabilities.
However, this situation is very rare in real life. Generally, the BOP of a country is in either
surplus or deficit.
When the inflow of foreign currency is more than the outflow of the country’s currency, the
BOP would be in surplus, whereas, if the inflow of foreign currency is less than the outflow of
the country’s currency, the BOP would be in deficit.
Simply put, BOP account is a statement of a country’s sources and uses of foreign exchange in
which main sources are: exports, transfers and remittances from abroad, borrowings from
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(iv) Mis-utilisation of Natural Resources: Excessive exports may exhaust the natural
resources of a country in a shorter span of time than it would have been otherwise. This will
cause economic downfall of the country in the long run.
(v) Import of Harmful Goods: Import of spurious drugs, luxury articles, etc. adversely affects
the economy and well-being of the people.
(vi) Shortage of Goods: Sometimes the essential commodities required in a country and in
short supply are also exported to earn foreign exchange. This results in shortage of these goods
at home and causes inflation.
(vii) Danger to International Peace: International trade gives an opportunity to foreign agents
to settle down in the country which ultimately endangers its internal peace.
(viii) World Wars: International trade breeds rivalries amongst nations due to competition in
the foreign markets. This may eventually lead to wars and disturb world peace.
(ix) Hardships in times of War: International trade promotes lopsided development of a
country as only those goods which have comparative cost advantage are produced in a country.
During wars or when good relations do not prevail between nations, many hardships may
follow.
Free Trade Vs Protection
Free trade
Free trade is the unrestricted purchase and sale of goods and services between countries without
the imposition of constraints such as tariffs, duties and quotas. Free trade is a win-win
proposition because it enables nations to focus on their core competitive advantage(s), thereby
maximizing economic output and fostering income growth for their citizens.
Free Trade Policy: Advantages
Policy of non-interference by government in foreign trade is referred to as “free trade”. Free
trade policy implies absence of any artificial restriction on or obstacle to the freedom of trade
of a country with other nations.
According to Adam Smith, the term “free trade” is used to denote “that system of commercial
policy which draws no distinction between domestic and foreign commodities and, therefore,
neither imposes additional burdens on the latter, nor grants any special favour to the former.
“In other words, free trade implies complete freedom of international exchange. Under such a
policy there are no barriers to the movement of goods among countries and exchange can take
its perfectly natural course. Classical economists like Adam Smith, Ricardo and others pleaded
for free trade for the welfare of the world.
Advantages of Free Trade:
1. Comparative cost advantage: Free trade is the natural outcome of the comparative costs
advantage. It permits an allocation of resources, and manpower in accordance with the principle
of comparative advantage, which is just an extension of the principle of division of labour.
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abroad, foreign investments whereas uses of foreign exchange are: imports, transfers to abroad,
lending abroad and purchase of assets, etc.
BOP account, like a typical business account, is based on double entry system which contains
two sides—Credit side and Debit side. Any transaction which brings in foreign exchange
(currency) is recorded on credit side whereas any transaction that causes a country to lose
foreign exchange is recorded on debit side. For example, export is credit item as it brings in
foreign exchange whereas import is a debit item since it causes outflow of foreign exchange.
Similarly, borrowing from rest of the world (ROW) is a credit item while lending to ROW is a
debit item. Main purpose of BOP Account is to know international economic position of a
country and to help the government make appropriate trade and payment policies.
The types of financial and economical transactions between two countries are listed as
follows:
a. Purchasing or selling of goods and services by the residents of one country from the
another country
b. Giving and receiving unilateral gift in kind by the residents of one country from the
another country
c. Giving and receiving unilateral financial gift by the residents of one country from the
another country
d. Investing in domestic and foreign securities
International Monetary Fund monitors the BOP of the countries and publishes annual reports.
It has set various rules to regulate the international trade and maintain stability in BOP.
Features of Balance of Payment Account:
(i) It is a systematic record of all economic transactions between residents of one country and
rest of the world.
(ii) It includes all transactions in goods (visible items), services (invisible) and assets (flow of
capital) during a period of time.
(iii) It is constructed on double entry system of accounting. Thus, every international
transaction will result in credit entry and debit entry of equal size.
(iv) All economic transactions that are carried out with the rest of world are either credited or
debited.
(v) In accounting sense total debit will always be equal to total credits, i.e., balance of payments
will always be in equilibrium. But in economic sense, if receipts are larger than payments, there
is surplus in BOR Similarly, if payments are larger than receipts, there is deficit in BOP.
Visible and Invisible items: Visible items refer to items relating to trading in goods with other
countries. For example export and import of goods (like machinery, tea, etc.) are called visible
items because goods are visible items and can be verified by Custom officials.
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For providing, regulating and creating necessary environment for its orderly growth, several
Acts have been put in place. The foreign trade of India is governed by the Foreign Trade
(Development & Regulation) Act, 1992 and the rules and orders issued there under. Payments
for import and export transactions are governed by Foreign Exchange Management Act, 1999.
Customs Act, 1962 governs the physical movement of goods and services through various
modes of transportation.
Characteristics of International Trade:
(i) Separation of Buyers and Producers: In inland trade producers and buyers are from the
same country but in foreign trade they belong to different countries.
(ii) Foreign Currency: Foreign trade involves payments in foreign currency. Different foreign
currencies are involved while trading with other countries.
(iii) Restrictions: Imports and exports involve a number of restrictions but by different
countries. Normally, imports face many import duties and restrictions imposed by importing
country. Similarly, various rules and regulations are to be followed while sending goods outside
the country.
(iv) Need for Middlemen: The rules, regulations and procedures involved in foreign trade are
so complicated that there is a need to take the help of middle men. They render their services
for smooth conduct of trade.
(v) Risk Element: The risk involved in foreign trade is much higher since the goods are taken
to long distances and even cross the oceans.
(vi) Law of Comparative Cost: A country will specialise in the production of those goods in
which it has cost advantage. Such goods are exported to other countries. On the other hand, it
will import those goods which have cost disadvantage or it has no specific advantage.
(vii) Governmental Control: In every country, government controls the foreign trade. It gives
permission for imports and exports may influence the decision about the countries with which
trade is to take place.
Advantages of International Trade:
(i) Optimal use of natural resources: International trade helps each country to make optimum
use of its natural resources. Each country can concentrate on production of those goods for
which its resources are best suited. Wastage of resources is avoided.
(ii) Availability of all types of goods: It enables a country to obtain goods which it cannot
produce or which it is not producing due to higher costs, by importing from other countries at
lower costs.
(iii) Specialisation: Foreign trade leads to specialisation and encourages production of
different goods in different countries. Goods can be produced at a comparatively low cost due
to advantages of division of labour.
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6. Free trade may encourage interdependence and discourage self-sufficiency. But, in the
matter of defence each country should have self-reliance and self-sufficiency as far as possible.
Free Trade Vs Protection Trade
A trade policy of placing no restrictions on the movement of goods between countries is known
as the policy of 'Free Trade.' Such a policy permits the flow of international commerce in its
natural environment, free of artificial impediments.
According to Adam Smith, the term 'free trade' is used to denote 'that system of commercial
policy which draws no distinction between domestic and foreign commodities and, therefore,
neither imposes additional burdens on the latter, nor grants any special favour to the former.'
In other words, free trade implies complete freedom of international exchange. Under such
policy, there are no barriers to the movement of goods between countries and exchange can
take its perfectly natural course.
The policy of free trade, however, does not require the removal of all sorts of duties on
commodities in international exchange. It insists that duties may be imposed exclusively for
revenue and not at all for protection.
Despite the clamour of the classical economists about the advantages of free trade, the policy
has either not been adopted by many countries or abandoned by those who already adopted it.
Economic history indicates that since the last two centuries, international trade has developed
with the protection policy.
Protection:
Protection refers to the foreign trade policy of encouraging home industries by paying bounties
(or giving subsidies) to domestic producers, or more usually by imposing customs duties on
foreign products.
The term protection usually carries in a very loose sense the connotation of a tariff on imports;
but it may refer to any policy that raises the price of import substitutes and safeguards the
interest of domestic producers against foreign competition.
Tariff system, i.e., customs duties, is an important and most common method of protection. By
tariff barriers we mean only those taxes which are intended to restrict international trade.
Protection is an established creed of modern trade policy. Yet it remains to be examined
whether, protection is a healthy policy leading to an economic millennium or a policy
abounding in hidden dangers.
Free trade policy has been abandoned by all countries for the following reasons:
1. Under the system of free trade, the underdeveloped countries suffer very much in
competition with the advanced countries. Free trade, policy in India adopted by the British
Government has proved that, the one-time flourishing industries (handicrafts) of India were
completely wiped out due to foreign competition. On the continent of Europe also, the people
knew the dangers of free trade, and they hastened to erect strong tariff walls to protect their
industries.
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 x Invisible items refer to items relating to trading of services with other countries and
unilateral transfers. Export and import of services are called Invisible items because
services are not seen crossing the border. All types of services like services of shipping,
banking, tourism, investment services and unilateral transfers are invisible items.

Components of Balance of Payment Account:

The various items which make up country’s Balance of Payment Account are:

1. Export and import of goods (Merchandise): The most straightforward way in which a
country can acquire foreign currency is by exporting goods. These are called visible items
because goods can be seen, touched and measured. Movement of goods between countries is
known as visible trade because the movement is open and can be verified by Customs officials.

2. Services rendered and received: (Shipping, banking, insurance, tourism, interest, dividend
etc.) Under this head, following types of earnings are included.

(a) Non-factor income: Income from shipping, banking, insurance, tourism, software services
is called non-factor income.

(b) Investment income (Factor income): Interest and dividends which citizens of a country
earn on investment abroad are investment income and treated as factor income.

3. Unilateral transfers: (Gifts, remittances, indemnities, etc. from foreigners). These items are
called unrequited receipts because residents of a country receive ‘for free. Nothing has to be
paid in return at present or in future for these receipts. These are like transfer payments.
Examples of this head are gifts received by residents from foreigners, remittances sent by
emigrants to relatives, war indemnities paid by a defeated country, etc. In India unrequited or
unilateral transfers are treated as a part of invisible trade.

4. Capital receipts and Payments: (Borrowings, capital repayments, sale of assets, changes
in foreign exchange reserve):
It records international transactions which affect assets and liabilities of domestic country with
rest of the world.

Government of a country may borrow (get loan) from another government; a firm may issue
stocks abroad or a bank may float a loan in a foreign country. In all these instances, the country
in question will acquire foreign currency and these transactions will be entered as credit items
in. Similarly foreigners may acquire assets in the country with whose balance of payments they
are concerned.

Assets maybe in the form of land, houses, plants, and shares, etc. Changes m stock of gold or
reserves of foreign currency are also included in. Analogously, if residents of the country in
their turn were to acquire similar foreign assets, this would give rise to outflow of foreign
currency and come as a capital transfer recorded as a debit item.

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